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What's wrong with theme-based mutual funds?

Prima facie theme-based mutual funds are a great way to make big money. Actually, it is all human psychology – what we commonly term as ‘herd mentality’ (or as some sophisticated people would say ‘momentum’). 

When lots of money is chasing a select sector, it is bound to appreciate fast. And in this momentum, you get the opportunity to make 'big' and 'quick' money.

However, the problem is that we just don’t know when the market fancy starts or when it ends. It could be months, it could be years. So you could either exit too early and miss the best part of the rally... or you may be too late to exit when all the cream is gone.

Time and again, something or the other will catch the fancy of the market. And then everyone will rush headlong into it. Once upon a time it was Technology and Dotcom. Then came Infrastructure and Real-estate. Today no one even talks about them. Now its Pharma and FMCG. Tomorrow, they too could be forgotten.

Moreover, theme-based funds defeat the three very basic ideas of investing in MFs viz. diversification, professional expertise and regular monitoring

Firstly, we are concentrating our portfolio and thereby increasing the risk. MF was supposed to be a route to diversify our investment, not concentrate it.

Secondly, we are taking a call on the market as to which sectors will do well and which won't. We have entrusted our money to a professional fund manager. Don’t you think we should invest in a diversified fund vis-à-vis a sector fund and leave it to his expertise and experience to decide on the potential sectors (in fact, that’s precisely his job)? Are we smarter than the fund manager?

Thirdly, since we don’t know when the tide will turn, we need to constantly monitor a theme-based portfolio. Again, we had opted for MF as we didn’t have much time to regularly monitor our investments.

Given all this, theme-based funds carry much higher risk than diversified funds. 

As such, it would be prudent to ignore theme-based / sector funds or at best invest only a small % of our corpus in them. [And make sure to follow the '10 Rules on How to Choose the Best Mutual Fund'.]

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