Defence, PSU and Other Thematic Funds: Read This First

A thematic fund invests mainly in companies connected to a particular theme. Defence funds focus on companies that make defence equipment or serve the defence sector. PSU funds focus on public sector undertakings, companies where the government is a major owner.

Other themes include manufacturing, infrastructure, consumption and technology. Our page on sectoral and thematic funds explains the category in general.

Themes usually catch attention after a strong run, often backed by news: government spending, new orders, official announcements or global events.

When prices have risen sharply and every conversation is about the theme, it feels like an opportunity. That is exactly the moment to slow down and think, because much of the good news may already be in the price.

When a theme becomes very popular, share prices can rise faster than company profits. That means investors are paying more for each rupee of earnings.

High valuations do not mean a fall is certain, but they leave less room for disappointment. A small piece of bad news can then cause a sharp drop. This is one reason late buyers in a hot theme often have a rough experience.

A diversified equity fund spreads money across many sectors. A thematic fund concentrates it in one area. If that area does well, the fund can rise sharply. If it goes out of favour, the fund can fall sharply and stay down for a long time.

Our page on risk and volatility explains why concentration increases swings.

The most common mistake with themes is buying after a big run and selling after the fall that often follows. Investors chase what has done well recently, buy near the top, then lose patience.

Our post on why your friend fund did better explains how chasing recent winners usually disappoints.

A theme that was popular can go quiet for a long time. Companies in it may still be good businesses, but if the market loses interest, prices can drift for years.

So a thematic fund needs a long horizon and real patience, more than a diversified fund. Ask yourself honestly whether you would hold it through five quiet years.

Public sector companies often have the government as a major shareholder. Their decisions can be influenced by government priorities, such as pricing, dividends or social goals, not just shareholder returns.

That can be positive or negative at different times. It is one more reason PSU funds can behave differently from the wider market.

A SIP spreads your buying over time, which helps avoid putting everything in at a peak. But it cannot fix a theme that stays out of favour for years. Use a SIP into a theme only with money you can leave for a very long time.

Defence companies depend heavily on government orders, which can be large but uneven. A big contract can lift a company sharply, and delays can hurt it.

The number of listed defence companies is also relatively small, so a defence fund may hold a concentrated set of stocks, sometimes with high valuations after a rally.

Diversified funds such as flexi cap or multi cap funds can increase their holdings in a promising sector when their managers see value, and reduce them when prices look stretched.

So you may get some exposure to a popular theme through your existing funds, with the added benefit of a manager deciding when to hold more or less. Our page on flexi cap versus multi cap explains these categories.

Many PSU and defence companies are also held by diversified large cap, flexi cap or value funds. You may already have some exposure without realising it.

Check the top holdings before adding a theme fund. Our page on portfolio overlap explains how.

• Keep it to a small part of your equity, not the core.
• Only use money you will not need for many years.
• Prefer a SIP over a lump sum, to avoid buying everything at a peak.
• Be ready for long periods of poor performance.
• Review it yearly against its benchmark, not daily against the news.

Our page on how many funds to hold explains how to keep the portfolio simple.

When a theme is popular, new fund offers often appear. A low starting NAV does not make a fund cheaper or better.

Our pages on new fund offers and NFO versus an existing fund explain what to consider.

If you removed the theme fund from your portfolio, would your plan still work? If yes, the theme is a small extra. If no, you may be relying on one idea too much.

Thematic funds often have higher expense ratios than broad index funds. Compare costs before investing, because over time they add up.

Our page on expense ratio explains how costs are taken.

• Thematic funds bet on one idea, so they swing a lot.
• Buying after a big run is the most common mistake.
• Keep it small, long-term, and preferably via SIP.
• Check overlap with funds you already hold.

We are distributors rather than investment advisers and we recommend no schemes. If you want help thinking through a theme fund, get in touch.