Some Stories Don't Have a Happy Ending

Editor's Views: Thematic funds are easy to understand and tell compelling investment stories, but beware of The Next Big Thing becoming a yesterday's fad

Holly Black 21 May, 2021 | 11:15AM
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Whether you’re a Harry Potter fan, a Lord of the Rings buff, or prefer to get stuck into an autobiography – we all love a good story. And this is true not just of book worms and moviegoers, but of investors.

The appeal of thematic funds is easy to understand – these funds don’t bamboozle us with talk of spreads, ROI, P/E and duration, they tell us a story and often one we can relate to. They speak to us of the rise of the robots, of the world’s ageing population, or the global shortage of water. These are stories we know to be true, and which affect our lives. It makes sense that we would want to find the investment opportunity within.

The stocks in which these funds invest in are exciting too – companies making nurse robots to care for the elderly or finding innovate ways to use artificial intelligence to enhance our online shopping experience. These are inventions we know will both affect and improve our lives. Of course we want a piece of the action.

But not all stories have a happy ending and knowing the difference between a fad and theme is crucial. These funds should come with a neon “Buyer Beware” sticker. Research shows that the survivorship rates on thematic funds (how long they last) are low compared to their mainstream counterparts. Why is that a problem? Because the main reason funds get closed is underperformance and outflows. We don't want fund launches being decided by marketing departments looking to capitalise on what's trending on Twitter, they should be determined by a manager's expertise and genuine need.

Because when investors move on to the Next Big Thing and the fad is over, so is the fund. Examples from the past include shipping funds, Y2K stocks, and even cigars. Spoiler alert: it didn't end well. It might now seem bonkers that anyone was backing these things, but at the time they were all the rage. 

What is the difference between a fad and a theme then? A theme, I would argue, is so structural and so embedded that we don’t even need to refer to it as such. The internet is, arguably, a theme – but it is so engrained in every aspect of our lives that we don’t need to search out companies specifically exposed to it. In fact, it would be harder to find companies not exposed in some way to the internet. This is, I believe, the direction of travel for ESG and sustainable investing too. Soon we will not have to define an ESG investment, because it will be harder to find those which are not.

Has Everything Changed?

One conversation I seem to be having a lot with people at the moment is: which of your habits from lockdown life are you going to endeavour to stick with post-lockdown?

Fund managers we spoke to think there’s set to be a major spending splurge as people return to the high street with the money they’ve saved from not being able to leave the house for a year. Others think we’ll all be dashing out to book all the experiences we’ve been missing out on for months – theatre trips, gig tickets and the like. Personally, I’m not so sure.

If lockdown had lasted a few weeks or months, I think we’d all have very quickly reverted to type. But after almost 18 months of changed behaviour, some new habits may be here to stay. You've only got to look at the announcement about Great British Railways this week to see just how worried companies are about this. 

And it all relates back to thematic investing, of course, because investors will need to identify the companies that can adapt to this new world and thrive in it, and those which will soon be a thing of the past. Consumers who were resistant to online shopping have been forced to get on board over the past year, and once converted are unlike to revert. With that in mind, recent predictions that the strong run of tech stocks is drawing to a close seems a bit overdone. 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Holly Black  is Senior Editor, Morningstar.co.uk