The downsides of thematic funds

A phrase you may have seen or heard lately is thematic investing.  Thematic funds offer investors exposure to investment “themes” such as biotechnology or artificial intelligence.  A video on the Bloomsbury Wealth YouTube Channel.

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Transcript: Robin Powell & Jeffrey Ptak/ Chief Ratings Officer, Morningstar.

RP: A phrase you may have seen or heard lately is thematic investing.  Thematic funds offer investors exposure to investment “themes” such as biotechnology or artificial intelligence.  So should you consider investing in one?  The first thing you need to realise is that thematic funds are considerably more risky than, say, broad-market index funds.

JP: What you’re talking about are very narrow slices of the market, and the themes can take different forms. It could be it could be the theme, could be artificial intelligence, it could be innovation, it could be a medical breakthrough, it could be something that has more of a political bed to it, you know? But in each one of these cases, you’re taking a slice of the market that represents companies that conform to the theme that you have defined and the attributes that make it up.

RP: You also need to remember that thematic funds tend to be launched after a period of strong performance by that particular theme.  So, by the time you start investing, the stocks within that fund may already be expensive.

JW: So what that means is we need to focus on sensible investment principles and we need to focus on the historical evidence to guide us because learning from our own personal experience will mean we’re going vulnerable to short-term noise, short-term fluctuations and poor quality feedback. The history of financial markets is incredibly important and focusing on robust, impartial evidence in how you frame your decisions is absolutely critical. The other point is to have a sound, sensible, evidence-informed set of investment principles that guide you. What are the key aspects? The hold over the long term in terms of investing, so long-term approach, diversification, compounding, those kinds of key unimpeachable principles should be your guiding light rather than short-term experience in markets.

RP: So a strategy may appear to have worked over, say, two or three years, that doesn’t mean it will carry on working. A strategy that’s worked over 50 years or more has far more credibility.

JP: Are they more often in the value column of the style box, the core column or the growth column of the style box?  And what you find is when you look at these thematics, around three quarters of them are in the growth column of the style box. What does that mean? It means that they’re growing, but it also means that they are not inexpensive. These tend to be pricey stocks explaining why these funds so often are plotted in that growth column of the style box, according quite a bit of price risk.

RP: The final thing to realise is that thematic funds tend to be very heavily promoted. Why?   Because investors are influenced by stories, and thematic funds almost always come with a compelling narrative.  So fund providers like them, and so does the financial media.

JP: We’ve all heard of story stocks in a sense. These are story funds. You know, it’s, it’s, it’s an easier sell when you can package up a set of securities, you know, slap an ETF name on it and go out to the market and say, you want a piece of this action, you know, you want to get on this train.

RP: In short, thematic funds are effectively concentrated bets. Of course, you might be lucky and get in and out at the right time.   But the evidence tells us that most thematic investors tend to buy and sell at the wrong time.  So, exercise caution. Great stories rarely make for great investments.

Disclaimer — The information in this video does not constitute advice or a recommendation, and you should not make any investment decisions on the basis of it. If you do however require advice please do not hesitate to contact Bloomsbury Wealth.