Identifying investment themes is what people think fund managers do, so why are thematic strategies so rare in DC? Paul Farrow investigates
Fund managers often talk about adopting a ’bottom-up’ or a ’top down’ strategy that might focus on growth or value plays. Yet a couple of decades ago another strategy started to emerge: thematic investing. It was a story that proved a good sell.
In 1999, for example, star fund manager Nick Train, who had just been recruited to M&G from GT Global, could be found waxing lyrical about Posh Spice. He was going to focus his attention on stocks such as Gucci, Johnson & Johnson, Gillette, EMI and American Express, which were linked to the Posh Spice theme, even though she had yet to marry David Beckham, because she was topping the charts with the Spice Girls. “Posh Spice is every fund manager’s dream,” he said at the time, as he handed out goodie bags packed with Gucci key rings and razors to journalists.
Not soon after, Train departed for pastures new and the fund’s remit was changed in 2005.
Then there was Merrill Lynch’s Global Titans fund. In 2000, the company invited people to “invest in 60 to 80 of the world’s biggest and most successful firms … the titans of the future”. Investors never made a penny and the fund changed its remit in 2007.
There was also Aberdeen global champions back then as it saw “an increasing demand for theme funds and for funds with a smaller, tighter portfolio of stocks.” The fund halved in value in next to no time.
It is why many may be sceptical of those that talk up the theme strategy today. Proponents of thematic investing argue it is rather less simplistic than that.
Guy Monson at Sarasin & Partners, the thematic investment house, says: “Using stories to illustrate thematic opportunities is valuable to educate and inspire the investing public, but is rarely sufficient to build durable long- term portfolios that can perform in a variety of market and macroeconomic conditions. Harnessing multiple themes helps solve this by balancing portfolio distribution but requires a more sophisticated investment process. The result is a diversified, often cash-flow rich global portfolio, that targets long-term growth in what, for some years yet, will remain a frustratingly low growth world.”
Sarasin thematic funds continue to sell and it has made some inroads into the institutional space, its company line being that a global thematic equities investment programme lends itself well to those employing core and satellite investment strategies.
Monson says: “Our philosophy is that geographical constraints are no longer relevant in the management of a dynamic blue-chip equity portfolio. Asset allocation is practiced by theme, regardless of geography.”
Two key drivers influenced its early thinking. The first was the impact Jack Welch was having at General Electric, the largest company in the world at the time. As well as being a diversified group, Mr Welch passionately believed that GE should be number one or two in every industry that it operated in and was obsessed by what was then an emerging definition of shareholder value. It aimed to adopt these into its investment thinking via a thematic investment approach.
It saw two other global trends at that time – the rise of the internet as e-commerce and the e-economy as well as the rapid integration of nearly 1bn new members to the global workforce.
Thematic advocates argue that we are living in a rapidly changing world – it is a comment that is difficult to argue against given the rise of China and India over the past decade and the influence they have on the world. Throw in technology which is changing at a rapid pace and the financial crisis and it is obvious to all that the bigger picture will influence the ultimate performance of assets.
Towers Watson is an advocate of thematic investing and throws a line from ice-hockey play to promote its wares: “A good hockey player plays where the puck is. A great hockey player plays where the puck is going to be.”
Towers says that thematic investing is about capitalising on future trends identifying the winners and avoiding the losers. It claims this ’forward-looking’ nature stands in clear contrast to the more widely used approach of market capitalisation investing, where it is implicitly assumed that past winners will continue to win out, and therefore deserve more attention.
“These global mega trends, or powerful seismic shifts will provide opportunities to investors who can take a long-term view,” said Brandi Wust at Towers Watson.
Towers looks at the investment world in terms of six categories: finance, economics, politics, society, environment and technology. But the categories are not independent; they are interconnected and are an evolving mix so the manager will have to have his or her wits about them not to be wedded to themes forever.
Towers uses the politics theme as an example of how themes can interconnect and disconnect.
During the Thatcher/Reagan era in the 1980s, finance and economics were generally perceived to be independent of politics, Towers says. But the same cannot be said today. Politics is now heavily intertwined with both finance and economics.
“The future of the euro is a political decision. The extent to which member countries are bailed out by the others, or to which they are willing to cede sovereignty to a central treasury function, is clearly in the realm of politics rather than economics or finance. However, the decisions made will have important and potentially widely differing impacts on perceived risks and asset prices,” says Wust.
“Similarly, we can see that it is likely to be fruitful to explore the overlap between technology and the environment. What happens here is, in turn, likely to have an impact on society and politics, and vice versa. Many other threads could be drawn, in any number of ways, through these categories.”
That is as maybe, but successful thematic investing is only as good as the manager or managers picking the themes.
Monson claims that none of its themes have been a disastrous miscall, although he admits that some were short-lived, such as profiting from deflation in the aftermath of the technology blow out in 2000.
At the moment intellectual property and innovation are his favourite themes. “Intellectual property and innovation is my personal favourite. It captures first the extraordinary breadth of new technologies that are being adopted in everyday production today. In terms of shareholder impact, strong corporate cash-flow and profitability are allowing technology to be deployed far more quickly and universally than could have been imagined earlier in the decade,” Monson says.
“Certainly the corporate balance sheet is becoming interesting with real and nominal interest rates at negative or near zero levels respectively across most of the developed world, while new technologies and distribution platforms are altering what it means to be commercially successful for many global brands.”
Towers admits that one of the key challenges of thematic investing is that the successful identification of themes does not necessarily lead to successful investments. “History is littered with examples of industries moving from being highly fragmented to concentrated – bicycles, cars, aeroplanes, computers – but gives no guide on how to predict which of the numerous initial companies will come to dominate an industry,” says Wust.
“Consequently, we need to redefine success, given that picking the individual winner will be too difficult. Instead, success for us will mean identifying the broad theme and a number of different ways to access that theme. This immediately suggests that successful thematic investing is more about selecting appropriate baskets of investments rather than trying to pick single securities. However, even the identification of themes is not easy, and we do not believe any one process can guarantee results.”
Thematic investing is not yet a defining theme for workplace pensions and it may struggle to be for some time to come. For example, the National Employment Savings Trust does not embrace thematic techniques when it comes to asset allocation and has no plans to do so either.
Scottish Life, which has its governed range reckons that thematic investing is likely to limit the investment universe in terms of identifying companies who are aligned to any one particular global trend. “Therefore by its nature it is likely to be more volatile, such as Blackrock Gold & General and JPM Natural Resources. For this reason they are more specialist funds, and more suitable for people with a higher risk profile. They therefore wouldn’t be suitable as a default,” says Lorna Blyth, investment marketing manager at Scottish Life.
Fidelity agrees that you will not see a thematic default any day soon.
A spokeswoman says: “We think that thematic investing is more difficult to incorporate into a structure where defaults play an important part in achieving the overall outcome. Themed investments can be somewhat short-term in nature and what is perhaps more relevant to DC investors is making sure that their allocation between the different asset classes is appropriate to their investment risk, age and desired outcome. If defaults are using passive it’s pretty hard to make an investment for thematic reasons as the fund will just follow the market cap of the index.”
Those DC members that are embracing the strategy are more likely to do so, albeit unintentionally, via specific funds in the diversified growth space – and so a player such as Newton which is also a major advocate of thematic investing is likely to take centre stage.
Catherine Doyle at Newton says: “We believe a successful DC investment strategy should be dynamic enough to take account of changing market, regulatory and economic factors. The thematic approach, in which no single asset class or company is seen in isolation but rather is considered in the context of the big forces and trends shaping the global economy, is an effective framework to construct and manage DC investment solutions.”
Doyle adds that this is the approach adopted by the Newton Real Return Fund which “has attracted significant DC asset flows in recent years as trustees and sponsors recognise the value of investment across a range of asset classes”
Consultants admit that thematic investing has been around for a while with investment houses such as Newton, Lazard or Sarasin, but they do not see it become dominant, largely because of the focus on getting costs down in the DC arena.
Paul Black at Lane Clark & Peacock LLP says: “Some fund managers have used thematic styles for years but it has not been driven by a need for DC to adopt that approach. It is not on the radar and the only time it might come up in conversation is when absolute return funds are discussed.”
Brian Henderson, investment consultant at Mercers adds: “We are quite agnostic on the concept but would say that they are useful in the mix,” he said.
It is another way of doing things – its not particular advantage over any other approach.”
Where thematic styles have been adopted, Henderson says, is with manager of manager propositions, but that is about as far as it goes. “When we have had multi-managers some thematic strategies crept into to DC, but the lion’s share is still with DB when it comes to workplace pensions. At the moment huge pressure is to get costs down so that puts the focus on passive investing and I’m not aware of a thematic passive index,” he adds.
(Clockwise from top left) Emerging markets; the eurozone; Victoria Beckham (“Posh Spice”); green investment