In recent years, thematic mutual funds have emerged as the latest trend in the investment world. With themes ranging from electric vehicles (EVs) and artificial intelligence (AI) to Environmental, Social, and Governance (ESG), investors are increasingly drawn to these focused narratives. The appeal lies in their ability to capture the essence of emerging trends, disruptive innovation, and long-term macroeconomic shifts. However, just because something is trending doesn’t mean it’s a fit for your portfolio.
Thematic funds operate on compelling stories. They’re marketed as windows into the future, allowing investors to benefit from the growth of a specific theme over time. Yet, these investments are far from guaranteed. They require deep understanding, careful timing, and emotional discipline.
In this blog, we’ll explore why thematic funds attract so much attention, how they work, the psychology behind their allure, and whether they truly deserve a place in your long-term investment strategy.
What Are Thematic Funds?
Thematic funds are a type of equity mutual fund that invests in a curated set of companies connected by a specific idea or trend. Unlike sectoral funds, which limit themselves to a single industry, such as banking or pharmaceuticals, these funds may span multiple sectors, provided the companies align with the central theme.
Examples of popular themes:
- Clean Energy: Companies focusing on solar, wind, hydrogen, and green fuel
- Electric Vehicles: Including battery makers, component suppliers, and EV infrastructure
- Digital India: Firms contributing to digital infrastructure, telecom, e-governance
- Artificial Intelligence: Businesses integrating AI into core functions
- ESG: Companies with strong environmental, social, and governance practices
- Infrastructure Growth: Linked to the government’s capex push
These funds are actively managed and highly selective, aiming to ride the tailwinds of megatrends expected to transform economies over the next decade.
Why Investors Are Attracted to Thematic Funds
1. Storytelling Power
Themes create compelling narratives. For instance, the electric vehicle theme suggests a cleaner, more sustainable future. AI promises to automate and enhance intelligence in everything we do. These themes appeal not just to logic, but also to emotion. Investors feel like they are participating in the next revolution, not just parking money.
Storytelling builds conviction when firm conviction can override logic, especially when backed by convincing marketing and media hype.
2. Fear of Missing Out (FOMO)
The fear of missing out is a strong psychological driver. Social media, influencers, and even WhatsApp forwards may highlight massive returns from a hot theme, triggering impulsive decisions. This FOMO-driven entry typically occurs when the theme is already in an upward trend, increasing the risk of entering at inflated valuations.
3. Perceived Higher Return Potential
Thematic funds can indeed deliver outstanding returns, but often only during specific cycles. A strong tailwind or regulatory support can send prices soaring, making these funds look like unbeatable options compared to plain-vanilla mutual funds. This track record, although short-lived, becomes the poster boy for marketing campaigns.
4. Targeted Exposure
Thematic funds provide investors with the opportunity to invest based on their personal beliefs or interests. Someone passionate about sustainability may prefer an ESG fund, while a tech-savvy investor might favour a digital or AI fund. This alignment provides a sense of purpose that extends beyond financial returns.
The Psychology Behind Thematic Investing
Behavioural finance plays a significant role in thematic investing. Several biases are at play:
- Confirmation Bias: People tend to notice information that supports their existing beliefs, often leading to a distortion of reality.
- Recency Bias: Investors tend to overemphasise recent performance, overlooking long-term risks.
- Availability Bias: Media coverage increases the visibility of specific themes, making them appear more profitable than they are.
When these biases combine with market momentum, thematic funds become a magnet for impulsive or poorly informed investment decisions.
Risks of Thematic Investing
1. Concentration Risk
Thematic funds often invest in a narrow group of companies. If the theme underperforms due to policy changes, technological disruptions, or global factors, your investment suffers. For instance, an EV fund is susceptible to battery input costs, government subsidies, and infrastructure readiness.
2. Cyclical Performance
Thematic funds are not consistent performers. They may outperform in specific cycles and drastically underperform in others. Unlike diversified equity funds, their returns are dependent on external factors, particular to the theme.
Example: Clean energy funds experienced a boom between 2020 and 2021 but saw corrections in 2022 due to raw material shortages and regulatory hurdles.
3. Entry Timing Matters
Timing is crucial with thematic funds. If you enter at a peak (when the media is most optimistic), you might face capital erosion when reality doesn’t match expectations. Unlike SIP-based long-term funds, these are sensitive to market sentiment.
4. Hype vs. Fundamentals
Sometimes themes take off based on projections, not performance. Companies with no profits but exciting stories can inflate their net asset values (NAV) by presenting them in a favourable light. When rationality returns, these funds correct sharply, leaving late entrants bruised.
5. Expense Ratio
Thematic funds are actively managed, and their expense ratios tend to be higher than those of passive or index-based funds. This eats into returns, especially when the theme is not performing.
6. Limited History
Many thematic funds are newly launched, especially during bull runs. This makes it hard to evaluate their performance across market cycles. New investors don’t get the complete picture of risk and volatility.
Inside India’s Thematic Fund Frenzy: Data, Returns & Reality
🔹 1. Explosive Growth in Thematic Fund Inflows
- In FY24, thematic funds saw ₹1.22 lakh crore in net inflows, the highest across equity categories. AUM jumped from ₹1.7 lakh crore to ₹2.93 lakh crore.
- For 2024, sectoral & thematic NFOs (new fund offerings) gathered ₹79,100 crore across 52 schemes, accounting for nearly 23% of total NFOs
📈 2. Record-Breaking Fund Inflow Surges
- The thematic category grew a staggering 488% year-over-year (Y-o-Y) in net collections, bringing in ₹1,09,711 crore in 2024, which accounted for 34% of total active equity flows.
- As of June 2024, monthly inflows hit ₹22,350 crore, accounting for 55% of all active mutual fund net flows.
- AUM for thematic and sectoral funds surged from ₹59,000 crore (Aug 2019) to ₹4.45 lakh crore (Aug 2024), a 7-fold increase
- By June 2024, sectoral and thematic AUM had reached ₹3.83 lakh crore, accounting for 39% of actively managed equity AUM.
🚀 4. Exceptionally High Returns
- Thematic funds delivered impressive CAGRs: 46% over 1 year and 21–24% over 3–7 years.
- Of the 32 thematic schemes, 20 posted 5-year rolling returns above 20%.
⚠️ 5. Risks & Drawbacks
- High risk due to concentration: thematic funds focus on a specific theme of> 80%, making them vulnerable if the theme falters.
- Expense ratios tend to be higher due to specialised management and research.
🗣 6. Investor & Expert Commentary
“To me, thematic fund is the biggest con to lure money from investors who think they are smart…”
These voices highlight scepticism about unsophisticated marketing and the potential for misaligned incentives.
Who Should Invest in Thematic Funds?
Thematic funds aren’t for everyone. They demand knowledge, patience, and the ability to tolerate volatility.
Suitable for:
- Investors with a high risk appetite
- People with a good understanding of macro trends or sectoral dynamics
- Long-term investors (7+ years) who can ignore short-term volatility
- Investors looking to allocate only 5-10% of their total portfolio.
Not suitable for:
- Conservative investors
- First-time mutual fund investors
- People seeking consistent, low-volatility returns
Remember: thematic funds should supplement your core portfolio, not replace it.
How to Evaluate a Thematic Fund
Before investing in a thematic fund, ask the following:
1. Is the theme structural or cyclical?
Structural themes (such as digitisation or financial inclusion) have a long-lasting impact, while cyclical ones (like commodity booms) may be short-lived.
2. Is the narrative backed by fundamentals?
Are the companies profitable? Are earnings sustainable? Avoid themes based purely on hype.
3. Fund Manager Expertise
The success of a thematic fund depends heavily on the fund manager’s skill to identify the right stocks. Choose AMCs with solid research capabilities.
4. Entry Point
Don’t rush in based on the past 1-year performance. Evaluate current valuations and broader market cycles.
5. Compare Alternatives
Would investing in a multi-cap fund or index give you similar exposure with less risk? Sometimes, diversified funds already include top stocks from trending themes.
Real Example: Thematic Fund Mania in India
Over a dozen thematic funds were launched in India between 2020 and 2023. Themes included international tech, electric vehicles (EVs), environmental, social, and governance (ESG), and infrastructure.
One such example is the EV and Battery Technology fund launched in 2021. During the bull phase, it saw strong inflows and delivered stellar 1-year returns. However, in 2022, due to global inflation, EV-related stocks corrected, and returns dropped significantly.
Another was ESG Funds, which surged due to global climate commitments. But debates around ESG standards and greenwashing led to re-evaluation and redemptions.
Lesson: Entering at the peak can result in capital loss. Most retail investors enter late, after headlines, and exit in panic when the cycle turns.
How to Use Thematic Funds in Your Portfolio
- Allocate only a small portion (5-10%) of your portfolio.
- Prefer SIP mode to average out volatility.
- Track theme updates regularly. If regulatory or global outlook changes, reassess the situation.
- Exit if fundamentals weaken or if the theme loses relevance.
- Treat it as a tactical, rather than a strategic, allocation.
Final Words
Thematic funds offer excitement, targeted exposure, and potential for high returns. However, they also carry concentrated risk, exhibit cyclical behaviour, and display emotional volatility. Most importantly, they require an investor to be informed, disciplined, and realistic.
Before jumping on the thematic bandwagon, ask: Are you investing based on a compelling story or a solid strategy? Let your core portfolio do the heavy lifting, and let thematic funds be the spice, not the staple.
If you’re unsure whether a thematic fund is suitable for your needs, consult a professional before investing.
Disclaimer: The information provided in this blog is for educational and informational purposes only and should not be considered as financial, investment, or tax advice. While every effort has been made to ensure accuracy, readers must consult a qualified financial advisor before making investment decisions. VSJ FinMart is an AMFI-registered mutual fund distributor (MFD) that does not provide investment advisory services. Mutual fund investments are subject to market risks; please read all scheme-related documents carefully before investing.