Quilter Cheviot warns of risks associated with thematic funds

‘It’s hard not to draw the conclusion that investing thematically is a tough job’

3 minutes

Quilter Cheviot has warned investors of the risks associated with thematic funds.

In a press release, head of research Nick Wood (pictured) said many thematic funds are growth biased and may have overlapping holdings. “With value having taken the lead from a style perspective, I suspect there are far fewer thematic funds performing well in that environment.”

Last year, thematic ETFs enjoyed record net inflows of $12.5bn. But recent data from JP Morgan shows a basket of 1,000 thematic funds has significantly underperformed the MSCI ACWI index over the last 16 years.

“Of course, within that set there would be some very strong performers no doubt. But it’s hard not to draw the conclusion that investing thematically is a tough job, in some ways as hard as a retail investor picking the right individual stock,” says Wood.

“The chances of investing in an individual theme early enough to make money, and likewise, exiting at the right moment is incredibly difficult. There is a significant risk that investors are more likely invest at the point where the theme has already gained ground and is in the wider domain, and naturally has already performed well.

“By the time they hear about it, the likelihood is that the ‘smart’ money has already made the best returns. Likewise, how do you know when to sell? Even if you have timed your entry well, if you don’t time your exit well you run the risk of losing those gains.”

Wood also warned investors to check the index fund managers are using to benchmark performance.

“Many active managers use a global index as a benchmark, which in no way reflects their universe, whilst a more specific index can often be dominated by a small number of stocks with large weights that make it uninvestable in practice and therefore not a great comparator. This makes it almost impossible to assess if performance is based on stock picking abilities over and above the style tailwind.

“Investors can also run the risk of being caught up in a gimmick investment. One ETF launched recently invests in breakfast commodities such as coffee, pork and orange juice. You have to wonder with a lot of these products if an eye-catching theme was more important than the investment principles in that case.”

Finally, he said many themes take a long time to deliver results.

“Investing in online retailers such as Amazon has been hugely profitable in recent years, but the hype around internet businesses first arose in the tech bubble in the late 90s,” he said. “Whilst we saw some extreme stock price moves, ultimately many of those businesses had relatively little substance at that stage.

“Likewise, sequencing DNA was a huge breakthrough for mankind, but it’s taken a number of years for scientists to speed up that process to the point where it’s really aided new drug discovery and ultimately allowed companies to profit from that breakthrough. New and emerging themes, such as the metaverse, could take equally as long to provide any sort of breakthrough.”

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