Theme funds are risky, but they can make money

Part I: Tempted by a theme fund? Listen up

Thematic funds may seem like a trendy option. But, remember, every fashion statement may not suit you. And just because something is in vogue does not mean it should be part of your wardrobe. Be choosy. Very choosy. Here's a checklist that will help you stay grounded.

1. Don't blindly follow a theme. See what sectors are targeted under it. Technology, as a sector, has ample representation in a diversified equity fund. Ditto for sectors that fall under 'Infrastructure'. A thematic fund should add value to your core diversified holding and not duplicate it.  

2. Are you bullish on a particular theme? Then consider such a fund, but not before doing your homework. Understand what the associated risks pertaining to such a theme are. Take Canexpo, a fund that seeks to benefit from investing in companies with substantial foreign exchange earnings. A look at the NAV since March 2007 shows a decline corresponding to the progressive appreciation in the rupee.  

3. Thematic funds could be deceptive. There have been a number of instances where investors have made impressive gains with funds. This does not imply that you cannot go wrong with a theme. In fact, chances are high that you could.

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4. If you consider yourself fairly risk-averse, walk away from such funds. Thematic funds take concentrated bets. The average allocation to the top three sectors for the 27 funds listed is 55.7 per cent. But the corresponding figure for a purely diversified equity fund would be 48 per cent.     

5. Are you truly convinced that a theme has the potential to reward you substantially over the long-term or are you getting swayed by what is in vogue? Remember the three MNC funds launched in 1998, 1999 and 2000? UTI MNC, Birla MNC and Kotak MNC all turned out to be below average performers. 

6. It would be wise to stay away from close-ended thematic funds. The thematic nature of the fund is itself risky. If you foresee a change in fortunes of the fund and choose to exit, you will be slapped with a heavy exit load.

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7. When investing in these funds, be prepared to block your money for whatever time frame you want to stay invested. When the going gets tough for specific sectors, your ability to exit at a gain will be hit. Ensure that you have other avenues or investments to tap.  

8. However, alluring they may appear to be, thematic funds should not form the core of your portfolio. Leave that to a few diversified equity funds. Thematic funds should be additions to your portfolio to spice it up and add a little bit of risk. If you find yourself with too many thematic funds, lighten the load. Stick to a maximum of two.

Part I: Tempted by a theme fund? Listen up