Focusing on yield opportunities with thematic expertise
If you want to invest in equities for the long term today, there is a colourful bouquet of options open to you. Investment approaches in which themes are the relevant benchmarks are also of interest. A distinction must be made between different forms.
Author: René Nicolodi, Head Equities & Themes
Thematic investments are attractive. Investors are looking for investment opportunities that focus on long-term trends such as digitalisation, climate change or demographic change. The focus on high-growth sectors and companies harbours potential returns. According to the Thematics Barometer published by BNP Paribas in collaboration with Coalition Greenwich in 2023, the proportion of thematic investments in Europe has risen by 20 per cent since 2020. Despite all the euphoria surrounding investment themes, it is important to always choose the time to invest with an eye on the valuation, as many investors often only get in after the good performance and run the risk of participating to an above-average extent in correction phases. Here, too, it is probably a good idea to consciously choose a strategic investment horizon so as not to be thrown off course by short-term fluctuations.
Whether active or passive, investors have the choice
Active thematic funds: fundamentally analysed
Such products are usually backed by a multi-member investment team of financial experts on the investment theme. They analyse the investment universe fundamentally, make investment recommendations and implement these in an appropriate manner as part of the portfolio construction. An in-depth understanding of the theme and, in particular, the selection of individual stocks are of great importance. Over the years, active theme funds have established themselves in themes such as "water" and "climate".
Thematic ETFs: The rule-based ones
Thematic ETFs are essentially rule-based and track a predefined (thematic) index. The set of rules uses predefined criteria to determine which shares are included in the ETF and their weighting. It also determines the intervals at which rebalancing takes place. There are thousands of thematic ETFs on the market today, including exotic themes such as "space exploration".
Focus on risk management
But watch out: Most investment themes are based on high-growth market forecasts. However, these alone are no guarantee of success. If many shares are issued by new and existing companies pursuing profit opportunities with the same investment theme, it is possible that the theme will ultimately underperform the market. At the same time, no investment theme develops in a linear fashion. It is in their nature that investment themes are subject to numerous influencing factors such as innovation, regulation or economic phases and therefore exhibit highly dynamic behaviour.
For these reasons, an active approach that keeps an eye on the bottom-up growth of earnings per share or the return on capital employed, among other things, may be appropriate. This also enables better management of the risk of losses. In a turbulent market environment, for example, it makes sense to temporarily weight a more defensive sub-topic higher in the stock selection process or to pay particular attention to portfolio diversification in general. The result of these degrees of freedom can be seen in the popular theme of "water". Over the past five years, the average "max. drawdown" of the ten largest active equity theme funds domiciled in Europe on "water" was -30.4 per cent, based on data from the financial information service Morningstar, while the theme ETFs fell by -32.0 per cent. Over the past five years, the average monthly loss for active theme funds was -4.7 per cent, while theme ETFs lost -5.1 per cent (in USD after costs). Risk responsibility is therefore actively taken and should help to minimise the impact of setbacks.
Significant performance difference
Active fund managers with a profound understanding of themes can set themselves apart through skilful stock selection. Their aim is to create added value for investors by outperforming the market return or beating indexed thematic products. A look at the "circular economy" theme shows that this can succeed in practice. The focus of investments here is on companies that are committed to resource-efficient operating processes and either benefit from the emergence of the circular economy or support it. Three years ago, there was only one European-domiciled ETF on this topic, but today the entire product universe (active and passive) comprises more than 20 alternatives. Against this backdrop, the most recent performance is of particular interest. While the European-domiciled equity thematic ETFs on the circular economy gained an average of +0.4 per cent over the past twelve months as at the end of March, based on Morningstar data, the average increase in value of the active vehicles was +11.3 per cent (in USD after costs). Admittedly, the track record is still short, but the difference in performance is striking. There may be various reasons for this. On the one hand, there is probably still a lack of experience in dealing with suitable thematic universes/indices, while on the other hand it can be assumed that active fund managers are more likely to find real yield pearls in new thematic areas.
