Thematic investing to add zing to overall portfolio

Thematic investing to add zing to overall portfolio
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Thematic investing to add zing to overall portfolio

Highlights

While the theme may have a long rope, the stock prices of those related to the theme may peak before the actual peak of the theme

There's no one rule of investing or one strategy that works well at least all the times. Wealth creation happens over long periods of time where one finds phases of volatility, null activity and frenzied momentum. One might call it business cycles, economic cycles or just plain individual life cycles (mood swings), there's always a constant change in the stock prices.

In the hindsight, we might be able to perfectly answer the reasons for these gyrations but very difficult to pinpoint well in advance, consistently. So, we keep hearing about various ways to accumulate wealth each with their own pros and cons.

This is the reason why investing becomes tough. It takes a lot more conviction and commitment to any idea that we might pursue in achieving the goals. This is highly true when investing in thematic rationale where even timing plays a significant role in the outcomes.

Thematic investing focusses on predicting new trends or evolution of trends and then takes advantage of as it plays out. It's different from the regular stock investing where one may identify a particular stock and invest.

In this an entire sector or related to that theme are considered as a basket case, though the portfolio may have select stocks benefiting out of that theme/trend. This is similar to the top-down strategy but is restricted to unravelling a particular theme. Investing in these could turn extremely profitable if the trend or theme plays out well, as planned.

Identifying a theme is critical as certain demographic, structural, regulatory or legislation could alter the way the businesses are done and could hence lead to disruptions at the extremes or evolutions in general. For instance, the rapid digitisation has evolved the business environment across the industries leading to greater adoption of technology in the operations.

These changes have benefitted not just the ones which drove the technology but also those who've adopted and implemented into their businesses. The first movers not only disrupted the incumbents but have created new niches. The recent announcement on PLI (Production Linked Incentive) across various manufacturing industries in India has led to announcements of capacity expansion by some companies.

This would impact that company's growth prospects while giving a larger fillip to the entire industry. Also, themes like urbanization and consumerism have driven in the earlier cycles while remaining formidable, influencing the overall economic growth of India and particularly in real estate, housing and areas of discretionary spending.

Even when looked at the broader allocations into region-specific the emerging economies stand in good stead for growth than those of the advanced economies when compared on the population, aging and other demographic factors. The lucrativeness of thematic investing begins not just at the identification of the theme and its appropriateness but care should be given on the weightage or allocation.

The proportion depends, however, on the risk appetite of the individual and the conviction levels. Of course, conviction should be derived out of rigorous research and risk management than mere narrative the theme offers. Misallocation would lead to undesired results – higher allocations could tilt the risk while lower allocation wouldn't make big impact on the portfolio.

While people consider market-cap-weighted in their portfolios, I prefer the risk-weighted allocation to themes. Ideally, one could restrict up to 15 per cent of their portfolios to these kinds of allocations. Another critical part of thematic investing is the timing. It's not just mere entry but also the exit plays an important role.

One has to also keep in mind that while the theme may have a long rope, the stock prices of those related to the theme may peak before the actual peak of the theme. So, be aware of these dynamics while keeping an eye on the macro factors that could destabilise the raging themes. It's ideal to rebalance the portfolio through tweaking the allocations.

One may resort to not employing the entirety of the allocation at the beginning, as the lead times could be longer initially. A better approach is to constantly increase the exposure as the results are seen or the markets begin to reward our conviction. Equally important is to peter down the exposures as valuations find higher forward discounting.

Thematic investing hence could remain on the fringes of one's portfolio. It could be a good tactical tool to add zing to the overall portfolio. If investing through mutual fund route, there're multiple options catering to various themes like that of ESG, rural consumption, technology and healthcare. ICICI Prudential has a thematic advantage fund of fund which invests across multiple themes where the contributed fund is invested across different other funds.

The allocation to the fund would vary depending upon the prevailing market conditions. The allocation to a particular theme and the proportion is at the discretion of the fund manager. This fund could be used as a good proxy to various themes happening as the fund house has a varied multitude of sectoral/ thematic offerings.

(The author is a co-founder of 'Wealocity', a wealth management firm and could be reached at knk@wealocity.com)

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