What is theme-based investment? What are its benefits – Explained

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theme-based investing

In a vigorously growing Indian economy, there is a considerable degree of confidence that an equity investment in India stands a strong chance of yielding positive returns. Randomly, the chance is high that a bet is safe & lucrative, and more importantly, a broad-based rally is highly expected. Hence, it is presumed that an investment made even in a broad basket of stocks could provide a healthy return. For example, Nifty50, the main indices, constantly updated barometer of stocks of varied sector, have proved a 5yr CAGR of 13.5%, which is in-line with the broadest stocks in the Nifty500 index of 14.7%. To put it succinctly, understanding the market’s dynamics and identifying a selection of thematic stocks or sectors is expected to result in significant outperformance compared to the overall market. Simultaneously, Realty has provided 25.3%, Capital Goods 21.4%, and Midcaps 19.4% CAGR.

Thematic investment is a compelling strategy for a well-versed investor. The essence of this approach lies in identifying and understanding the current imperative needs, specifically focusing on pivotal areas of economic and industrial advancement. A prime example is the global imperative to address climate damage and restoration. Countries worldwide are formulating policies and supporting domestic industries to meet this critical demand. Being the key requirement of the whole world, the gaps between demand & supply are wide. Like for raw material resources, capital goods and institutions to generate & buy renewable energy. Despite the mismatch, it is a central investment criterion with high inflows being a focal area of development over the next 2-3 decades, leading to excess valuation due to lack of opportunity. Hence, companies & areas focused on the area are performing well. But based on their size and revenue outlook many may not be a rationale investment optional.

Cusp is to keep an eye on new developments taking place in the economy, industry, and company, for which comprehensive research and analysis may help identify themes with long-term potential. Thematic investing, which hones-in on specific trends, underscores the significance of diversification. This strategic approach helps to mitigate risks associated with individual stocks, which may lose traction over the long term and often carry high valuations. Constant review and restructuring of the basket are required, with profit and loss in between. Themes often take time to unfold, and short-term market fluctuations may impact the theme higher being high beta stocks.

While thematic investing offers the potential for high returns, it also comes with inherent risks. If the risk appetite is low and the investment horizon is short, investors must employ effective risk management strategies like hedging, diversification, investing only in large companies, avoiding mid & small caps, investing only in low beta stocks, and even setting stop-loss limits. Understanding the risk-return profile, objective, time, and risk involved in the theme is crucial for aligning investments with individual’s risk tolerance.

As India continues to undergo transformative changes across various sectors, thematic investing provides a unique avenue for investors to align their portfolios with the country’s growth story. By embracing these strategies, investors can navigate the complexities of the market and position themselves for success in the ever-evolving landscape of India as a thematic growth model.

Thematic investing involves constructing portfolios based on macroeconomic & industry themes as well as general cyclical trends based on the sentiment of the market. Understanding the pulse of the stock market is the key here.

In the Indian context, themes can range from the rapid digitization of the economy (JanDhan, GST, Adhar (govt services), UPI, Datacentre), high infrastructure & govt pending, developing as a manufacturing hub, and sustainable practices to renewable energy as a future source of energy.

In manufacturing, it includes sectors that will substitute for and augment new exports, including electric to engineering goods. A sector that has already been upraising in the last 10yr is Pharma and Chemical, which is expected to maintain its advancement with a slowdown in China. Companies directly and indirectly progressing to the accompaniment of Solar, Wind, Biofuel, hydrogen fuel, electronic vehicles, technology, and mass global production lines are upcoming areas in India. Otherwise, new generation companies are also evolving rapidly given India’s large domestic economy like ecommerce, Fintech, Foodtech, Edtech and varied types of products & services in advancement to old economy.

First published in Mint

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