What are Consumption Mutual Funds and How it Works?

Investing in the stock market can often feel like navigating a maze, with numerous funds and sectors contending for attention. One such intriguing investment option is consumption funds. But what is consumption fund, and how can it benefit investors? If you have ever purchased a product from companies like Hindustan Unilever, ITC, or Maruti Suzuki, you have directly contributed to the growth of companies that form the backbone of consumption funds.

These funds focus on businesses that manufacture goods and services consumed daily, making them a unique and promising investment avenue. In this article, we will explore the concept of consumption mutual funds, their advantages, risks, and how to identify the best consumption fund for investment.

Consumption Mutual Fund Meaning

Consumption funds are thematic mutual funds that invest in businesses directly catering to consumer needs. These companies manufacture goods and services that are used regularly, including food, beverages, personal care items, automobiles, and telecom services. The underlying principle of consumption funds is simple: as consumer demand grows, the companies supplying these goods and services thrive, leading to potential gains for investors.

How Do Consumption Funds Work?

Consumption funds operate by investing in stocks of consumer-oriented companies, primarily focusing on sectors such as FMCG (Fast-Moving Consumer Goods), automobiles, banking, and telecom. These funds are subject to market trends and consumer demand, making them highly sensitive to economic shifts.

For instance, during periods of economic growth, consumers tend to spend more on discretionary items, boosting the stock prices of relevant companies. Conversely, during downturns, demand for essential goods remains stable, ensuring that certain segments of consumption mutual funds maintain resilience. However, as with any investment, these funds come with risks, particularly concerning market fluctuations and changing consumer behaviour.

Key Benefits of Investing in Consumption Funds

Growth potential: Consumption-oriented businesses generally experience steady growth due to constant consumer demand. As India’s GDP and per capita income rise, so does consumer spending, which in turn benefits consumption funds.
Resilience in economic downturns: Unlike cyclical industries, companies in the consumption sector offer essential products that remain in demand regardless of economic conditions. This makes consumption mutual funds relatively more stable than other sector-specific funds.
Long-term wealth creation: Leading consumption-oriented companies like ITC, HDFC Bank, and Hindustan Unilever have consistently delivered good returns. This demonstrates their ability to generate long-term wealth for investors.
Portfolio diversification: Investing in a consumption fund can add balance to a portfolio by providing exposure to companies that operate in essential and high-demand sectors.

Types of Consumption Funds

FMCG-Focused Funds: These funds invest in companies that manufacture essential goods such as food, beverages, and household items. FMCG companies tend to have steady demand irrespective of economic conditions, making them relatively stable investments. Some key players in this segment include Hindustan Unilever, Nestlé, and ITC. These companies benefit from consistent consumer demand and established brand value.
Automobile-Oriented Funds: These funds focus on vehicle manufacturers and auto-component producers. The automobile industry is driven by consumer demand for mobility and technological advancements in vehicle production. Companies like Maruti Suzuki and Tata Motors fall under this category. Investments in automobile-oriented funds benefit from growing consumer aspirations, increasing urbanisation, and government incentives for the automobile sector.
Banking and Financial Services Funds: Since financial services play a critical role in consumer spending, these funds invest in banks and other financial institutions. Companies like HDFC Bank and SBI provide loans, credit services, and financial products that fuel consumer spending. The growth of banking and financial services is tied to economic expansion and rising disposable incomes, making them a significant part of consumption funds.
Telecom and Technology Funds: With the increasing reliance on digital services, funds investing in telecom and technology companies have gained traction. Telecom giants like Bharti Airtel and Jio play a crucial role in everyday consumer activities, from communication to entertainment and financial transactions. Investments in this sector benefit from rapid digitalisation, increasing smartphone penetration, and the expansion of internet services.

Factors to Consider Before Investing in Consumption Funds

Risk profile: Thematic funds, including consumption mutual funds, come with concentration risk, as they rely on a specific industry’s performance. Investors should assess their risk appetite before investing.
Investment horizon: To mitigate risk, it is advisable to invest in consumption funds for at least 5 years. This ensures that short-term market volatility does not significantly impact returns.
Market conditions and consumer behaviour: Consumption trends evolve over time, influenced by factors such as changing lifestyles, digital adoption, and economic shifts. Investors should stay informed about these trends to make sound investment decisions.
Diversification within the portfolio: While a consumption fund provides exposure to consumer-driven sectors, it lacks diversification beyond its theme. Investors should ensure they balance their portfolio with other asset classes.

How to Choose the Best Consumption Fund?

Historical performance: Investors should review the past performance of a fund over different market cycles to assess consistency.
Expense ratio: A lower expense ratio translates to better returns over time, making it a crucial consideration when choosing a fund.
Fund manager’s expertise: An experienced fund manager with a strong track record in managing thematic funds adds credibility to a consumption fund’s potential performance.
Portfolio composition: Examining the fund’s holdings and their sectoral allocation helps investors understand where their money is being invested.

Risks Associated with Consumption Funds

Market volatility: Since these funds focus on a specific sector, their performance is directly linked to consumer spending trends, making them vulnerable to economic downturns.
Regulatory changes: Government policies and regulations affecting consumer goods, taxation, or banking can impact the profitability of companies in the fund’s portfolio.
Changing consumer preferences: Consumer behaviour is constantly evolving. Brands that dominate today may lose relevance over time, affecting fund performance.
Inflation and economic conditions: Rising inflation can impact the pricing power of consumer goods, reducing profitability for businesses and, consequently, affecting consumption funds.

Conclusion

Consumption funds offer investors a unique opportunity to capitalise on the ever-growing consumer sector. With investments in essential goods and services, these funds provide stability, growth potential, and long-term wealth creation. However, they also come with inherent risks, including market volatility and regulatory changes.

Choosing the best consumption fund requires thorough research, considering factors like historical performance, expense ratio, and portfolio composition. While these funds can be a valuable addition to an investment portfolio, they are best suited for experienced investors with a long-term perspective. As with all investments, it is essential to assess personal financial goals and risk tolerance before making a decision.