 "Innovation funds: High-risk bets that are apt for seasoned investors")
Innovative companies can grow at a pace that their traditional rivals cannot match. To capture the growth of such companies, several mutual fund houses have in recent times launched innovation-themed schemes that invest only in such trailblazers.
Bandhan Innovation Fund is the most recent entrant into this category.
“Currently, the innovation theme is gaining prominence. India’s global innovation rank has improved from 81 to 40 over eight years (2015-2022). Bandhan Innovation Fund seeks to capitalise on advancements in fields such as retail, industrials, fintech, auto, etc. by investing in innovation-driven growth companies,” says Manish Gunwani, head-equity, Bandhan Asset Management Company (AMC).
Mutual fund houses like ICICI, Nippon India, Baroda BNP Paribas, UTI, and Union are already offering innovation-themed schemes. Kotak, DSP, and Axis provide fund-of-funds that invest in global innovation-focused schemes.
Innovation schemes invest at least 80 per cent of their money in shares of companies having a robust innovation framework.
What works in their favour?
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Innovation, whether in products, processes, or distribution methods, can significantly alter the demand for a company’s products and services. These innovations often include new-age, tech-based solutions to longstanding problems or enhancements that lead to cost efficiencies. Such improvements can transform a business into a profitable venture with a wide customer base getting attracted to its offerings.
The government’s emphasis on production-linked incentives, pro-growth regulations, and support for the startup ecosystem are expected to benefit companies that invest in innovation.
“Investing in these schemes offers the potential for high growth and returns, exposure to innovative industries that could shape the future, and an opportunity to diversify one’s portfolio beyond traditional sectors,” says Farhad Gadiwalla, head of products, UTI AMC.
Innovation-themed funds can create windfall gains for investors if their bets pay off.
“This theme could generate higher alpha compared to traditional diversified equity funds, as the market tends to reward innovators with higher equity multiples than traditional companies,” says Parul Maheshwari, certified financial planner.
Successful innovative companies can disrupt industries and seize significant market share from established leaders. “The rapid adoption of artificial intelligence, renewable energy technologies, and biotechnology, for instance, has fuelled growth in these sectors, resulting in substantial returns for investors,” says Gadiwalla.
Keep risks in mind
The intense competition in the race for innovation carries significant risks for investors.
“Innovation creates a competitive advantage only if it cannot be replicated by competitors. There is a risk that innovative products and processes may be difficult to protect. Moreover, for businesses with limited cash resources, the high opportunity cost of investing in research and development (R&D) can significantly increase their risk,” says Gunwani.
These businesses, particularly the ones incurring losses, require careful monitoring. They may take longer than anticipated to become profitable for their shareholders. “It’s important to recognise that not all companies in the innovation space will succeed,” says Gadiwalla.
Innovation schemes tend to have more concentrated portfolios than diversified equity schemes. “They also often have lower exposure to banking and old economy sectors that typically score low on innovation,” says Maheshwari.
These schemes have limited track records, and their returns vary significantly.
Who should invest?
Innovation schemes are suitable for seasoned investors willing to take very high risks. Such investments are typically suited to an investor’s satellite portfolio.
“These are ideal for investors seeking to diversify their satellite portfolio for potential alpha generation. Patient investors can participate in the innovation theme over a long-term horizon, especially through systematic investment plans (SIPs),” says Gunwani.
Gadiwalla says people should consider remaining invested for five to ten years to benefit from the entire cycle of non-linear growth of the portfolio companies.
Take a detailed look at the scheme’s portfolio before investing.
“High risk takers looking to diversify their equity mutual fund portfolios beyond traditional equity funds could consider investing in these schemes. Conservative investors should stick to diversified equity funds as they have a broader investment mandate. Investors should not allocate more than 10 per cent of their equity portfolios to such schemes,” says Maheshwari.
Take a detailed look at the scheme’s portfolio before investing.
“High risk takers looking to diversify their equity mutual fund portfolios beyond traditional equity funds could consider investing in these schemes. Conservative investors should stick to diversified equity funds as they have a broader investment mandate. Investors should not allocate more than 10 per cent of their equity portfolios to such schemes,” says Maheshwari.