Thematic funds: Why investors are now following stories instead of indices

Diversification and equity investing have been almost the same thing for decades. A diversified fund gave you exposure to many different industries, which helped you ride the overall growth of the economy and smooth out the shocks of any one sector. It was neat, made sense, and mostly worked.

Image for representational purposes only. (Unsplash)

But if you look at the Indian fund industry today, you'll see a new trend starting to take shape. Sectoral and thematic funds, which used to be thought of as niche, have been growing very quickly.

This change brings up an important question: why are more investors moving towards themes and sectors instead of sticking with broad-based diversification?

Think about the "consumption" theme. It isn't just a bunch of stocks in fast-moving consumer goods or cars. It's a bet on the growing middle class in India, rising incomes, and more people moving to cities. In the same way, "healthcare" isn't just about drugs. It shows bigger changes in the structure of society, like an older population, more people wanting insurance, more diagnostic chains, and more focus on health.

People can see these changes in the real world. People who invest in these kinds of themes can feel like they are a part of India's bigger story of economic change. The emotional connection makes thematic funds easier to understand than a diversified index fund with hundreds of unknown companies.

So, thematic investing is more about owning an idea than it is about owning the market.

This is where the two sides of thematic funds come into play. They are exciting because they could do very well in some situations. But they are also risky because it's hard to know when those phases will happen.

So what makes them more popular even though they are risky?

For example, having a defence fund makes you feel like you are helping India become more self-sufficient and modernise its military. It feels like supporting the government's "Make in India" vision to have a manufacturing theme. These choices help people feel like they belong. They let investors say things like, "I don't just own stocks; I own the future of Indian consumption," or “I'm supporting India's healthcare growth story.”

This doesn't mean that investors are giving up on diversification completely. Instead, they are making a "satellite" part of their portfolios to show their conviction. The "core" stays steady and diverse, while the "satellite" shows support for a theme.

It is also a myth that thematic investing is only for short-term trades or one-time investments. In practice, investors can also systematically participate by gradually averaging their way into themes without trying to guess cycles.

One of the most dangerous ideas is that the best theme to choose is the one that has done the best lately. In the past, many times, the winners of the market became the losers the next day. Trying to get better often leads to disappointment.

There are effects from that change. It makes investing more exciting and fun, on the other hand. When people can connect their money to trends they believe in, they feel closer to it. On the other hand, there is a risk of over-concentration if investors get too excited and don't see how markets change over time.

Thematic funds aren't just ways to make money in the end. They show how investors feel about change and how they want to be a part of it.

Chakrivardhan Kuppala is co-founder and executive director at Prime Wealth Finserv Pvt. Ltd.