The pulse of growth in a rapidly developing economy is consumption. The consumer-driven sectors, which make up a substantial part of India’s GDP, are FMCG, automobiles, retail, food, and discretionary spending.
Consumption mutual funds that focus their investments in these industries have thus become popular with investors looking to ride the domestic demand wave in India. In this blog, we shall look at whether consumption funds are risk-bound or not.
What Are Consumption Funds?
Consumption funds are thematic mutual funds that directly or indirectly invest in companies related to consumer spending. For instance, the Aditya Birla Sun Life Consumption Fund by Aditya Birla Mutual Funds has major investments in sectors such as Regional Banks, Personal & Household Products., Computer Services & Food Processing.
The consumption fund is a bet on the rising middle class, increasing disposable incomes, and the trend of urbanisation in India. At the very core, the more people spend, the more the revenue of companies serving consumers goes up.
The most popular funds in this category include Nippon India Consumption Fund, ICICI Prudential India Consumption Fund, and SBI Consumption Opportunities Fund.
Why Consumption Funds Carry Risk
Consumption funds, despite their growth potential, are not risk-free. Here are a few reasons behind the risks that consumption funds carry:
Concentration Risk
The consumption funds are thematic funds, meaning their investments are concentrated in a few sectors. So, when those sectors underperform due to inflation, slowing demand, or weak rural income, returns of the consumption funds reduce.
Valuation Risk
Because consumption stocks have steady cash flows and robust brand equity, they have often been traded on high P/E multiples. This thus means that they can be overrated or overvalued, with a reduced margin of safety in case of reduced earnings or altered market sentiment.
Inflation and Interest Rate Sensitivity
Higher inflation is also boosting the cost of production for consumer products, like raw materials and packaging, thereby depressing the margins. There is also the risk of a decline in discretionary spending on autos, housing, and consumer luxuries due to higher interest rates.
Shifting Consumption Pattern
Consumer preferences change very fast in today’s digital world, with many options available. The shift to digital-first brands from traditional ones, or changes in lifestyle trends, may affect established companies and, therefore, fund performance.
Are Consumption Funds Suitable for You?
Consumption funds may be a smart addition for an investor’s portfolio who:
- Believe in India’s long-term domestic consumption story.
- Be prepared to take higher risks and tolerate short-term volatility
- Would like to invest a part of their portfolio in thematic funds
How to Invest Smartly in Consumption Funds
Here are some of the tips that smart investors may follow to invest in consumption funds:
- Systematic investment plans, or SIPs, ensure averaging of entry points by reducing volatility.
- Track the inflation and interest rate trends as these directly influence consumption dynamics. Diversification within the portfolio prevents investors’ portfolios from being over-exposed to one theme.
- Determine the quality of fund management to choose funds with strong management performance and a disciplined approach to the selection of stocks.
Conclusion
Consumption funds are not strictly risk-bound, but they are theme-bound, i.e., their performance will depend on the Indian consumption economy. When the economy is growing, they deliver appealing returns; when the pace of growth slackens, especially with high inflation or lower consumer spending, they underperform.
Consumption funds add a dynamic growth factor to a diversified portfolio for investors who have a long-term horizon and believe in India’s domestic demand. The key to success with consumption funds lies in moderation, timing, and staying invested for the long term.
