The potential of “well-researched and set-up” thematic funds to outperform the broader stock market has been underscored by their showing in the wake of the crisis brought on by the Covid-19 pandemic, according to one expert in the field.
In spite of recent criticism of thematic portfolios from some quarters, Andreas Fruschki, head of thematic equity at Allianz Global Investors, believes that, when structured correctly, business models selected for these funds should outperform because of their rising relevance.
Complement core holdings
According to a 2020 analysis by Morningstar, the long-term performance figures of thematic funds suggest that investors’ odds of selecting a fund that will survive and outperform over the long run are slim.
It can be challenging to select the ‘right’ thematic fund that is able to outperform, as there are often few firms that are “pure plays” within a theme, the report found. Pure plays are companies that focus on a single type of product or service.
“Because of their narrow exposure and higher risk profile, thematic funds are best used to complement rather than replace existing core holdings,” Morningstar said.
Lower performance can be partly attributed to the higher fund fees of some thematic funds compared with their non-thematic counterparts.
Pandemic performance
Nevertheless, assets under management for these funds in Europe have tripled to $105bn (€93.3bn), reflecting their increasing attraction.
As an example, the Allianz Thematica (A – EUR) and the Pictet – Global Megatrend Selection (I – EUR) aggregate different single themes in a portfolio and both have outperformed their benchmarks during the recent market volatility.
The retail share class of the €394m Allianz fund returned 3.11% to the end of May, while its benchmark, the MSCI ACWI Total Return, fell 8.33% over the same period. The fund covers themes including digital life (29.3% of the portfolio), clean water and soil (20.6%), energy of the future (14.2%), health technology (14.2%), education (9.6%), artificial intelligence (7.3%) and the so-called ‘pet economy’ (4.8%). An institutional share class of the fund was launched in June last year.
Pictet Asset Management’s €8.49bn fund returned -3.41% to the end of May, compared with its benchmark, the MSCI ACWI, dropped by 8.33%. The fund invests in sectors such as information technology (20.21%), healthcare (17.99%), industrials (13.15%), consumer discretionary (12.02%), consumer staples (8.38%), materials (7.99%) and others.
Steve Freedman, senior product specialist, thematic equities, at Pictet, said that “on average, our thematic funds have outperformed the broad global equity markets (MSCI ACWI) over the last decade”.
Capturing growth tranches
Pictet and Allianz argue that thematic funds have an advantage in terms of the selection of holdings compared with custom approaches.
Investment themes are able to capture “overarching growth opportunities that go beyond traditional classifications based on industries, countries and regions”, Pictet wrote in a 2019 analysis.
“This suggests that a global portfolio with investments across a diversified basket of complementary thematic equities offers a potentially more efficient allocation of capital than one constructed using traditional regional building blocks,” it added.
A spokesperson at Allianz explained to Expert Investor that thematic funds were able to define a specific lens.
Whereas sector classifications on water could limit the choice of stocks by region, for example, thematic funds can select water suppliers as well as suitable industrial and technology stocks that offer innovative solutions against water scarcity.
Defining themes
Freedman highlighted the importance of defining the themes correctly, noting: “Some performance issues can emerge when themes are too narrowly defined and therefore not sufficiently diversified.
“At Pictet, we put considerable effort into defining new themes to ensure they are viable for the long term and broad enough. At the least, thematic portfolios should be viewed as long-term investments rather than tactical plays.”
In cases when the fundamentals of a theme have evolved adversely, Pictet has repositioned the theme “to better capture forward-looking growth drivers”, he added.
Allianz’s Fruschki agrees, explaining that “when it comes to thematic investments, it is of central importance to differentiate short-term fashions from long-term structural changes”.
To reflect this, themes at Allianz are defined as a sub-category of megatrends, he said.
Portfolio strategy
Depending on the theme, Pictet and Allianz see possibilities to invest in thematic funds as part of a portfolio’s core holding rather than being merely complementary.
Freedman said: “Identifying the right fund can indeed be challenging. This speaks in favour of diversifying across multiple thematic portfolios.
“[But] it is possible to create a thematic universe that is fairly well diversified across multiple sectors. In addition, a portfolio that is diversified across multiple themes can achieve a risk-return profile that makes it eligible to be included in a core allocation.”
Pictet’s analysis found that “a multi-themed thematic equity portfolio can diversify sources of risk and return just as effectively as investments referenced to a global stock index”.
Fruschki added that, when setting up thematic funds, it is important that the amount of “pure plays” is sufficient.
His team has found that, if at least 100 corresponding “titles” worldwide exist, a topic can be mapped diversified and efficiently.
However, he warned that investors should avoid thematic funds that have a smaller number of holdings.
