Max Pacella
Investment Analyst
Macro & Markets
13 Aug, 2021

Yesterday, Jesse made the point that inflation is psychological.

I’d like to take that one step further and assert that much of investing itself is psychological, more specifically how our own psychology helps us have conviction in an investment.

So much of markets is driven by sentiment, a point we have discussed extensively across many topics. A significant part of sentiment is our belief in the investment, also referred to as our “conviction” – how sure are we that the world will continue to embrace electric vehicles, as one simple example.

This ranges from “this miner is going to strike gold” all the way to complex economic forecasts based on the effects of fiscal and monetary policy within certain sectors. Often times, the simplest ideas are the ones which gather the most attention from the market: ideas form the core of a trade on which a thesis can be built upon regarding its long term implications.

The same goes for financial advisers providing solutions for their clients – a driving idea or theme simplifies an investment, and helps to bring the client along for the ride through a better understanding of the long-term outlook for the company or sector.

For the sake of keeping a very broad topic concise, today we will explore the concept of thematic or “idea” investing in the context of managed funds, “fascination funds” if you will, and how they can play a roll in a portfolio from a return and sentiment point of view.

Fascination Street

Before we give an overview of current popular themes, it’s useful to note why people may choose to pursue one particular thematic fund over another.

1. Narrative

What kind of story does this theme tell? What kind of story does it tell you about the future, what kind of story can you tell your client?

A fund that is focussed entirely on impact and sustainability, potentially (but not necessarily) foregoing absolute return for the sake of a positive environmental and social return, has a much different appeal and narrative to a fund that captures an e-sports/video game theme which is entirely around the rapid growth of gaming at a commercial level.

This is the “why” of the investment, the first filter which will decide if this is the right fund for you. Thematic funds are one of the rare instances where that why may not always be “to make as much return as possible”, and subsequently can have differing investment screens.

2. Prospect

How likely is the prospect that this Fund will deliver the desired outcome based on its mandate? What is the investible universe that it can access? Does that universe and strategy align with “what it says on the tin”?

This step holistically represents the due diligence you conduct on the manager’s strategy and execution.

A great example of where “prospect” fell apart was a client who came to us looking for a green portfolio, after what was proposed as an ESG ETF had Google, Amazon, Apple as some of its top holdings – which score well for ESG, since they have the balance sheet to purchase carbon credits and fund green initiatives on the side of their regular businesses. This ETF did not align with its supposed theme for this investor, although the idea behind it did.

This is the “how” of the investment. You’ve bought the premise, you’re ready to get exposure to this theme, now how is this fund actually going to get you exposure to it?

3. Comparison

And finally, we come to the ”who” of the investment.

There are many managers to choose from, particularly in some of the larger themes we are about to touch on, so how do you tell them apart and decide who is best to allocate your (or your clients) funds to?

There are many different means of assessing an investment manager, many adviser practices have likely spoken to asset consultants or read research reports which do a terrific job of providing insight into how you can weigh up the merit of a manager.

As a brief summary of key points we look for in managers, once we’ve chosen a theme and concluded that they are able to execute appropriately:

Past performance relative to benchmarkFund inception date/history of strategy
Past performance relative to peersHistory and expertise of management team
Sectoral and geographical exposureManager style consistency and success
Concentration of portfolio holdingsTurnover of investment team
Fund size (relative to market cap of holdings)Philosophy and approach to risk
Volatility, Sortino and Sharpe RatioMarket conditions vs manager style

As a side note: we often look at fees last, as these can skew your preference towards the cheapest option, which may not always be the best. A fund that performs 5.0% p.a. higher than its competitor, for a 0.10% p.a. higher fee, is not difficult maths.

What’s the Big Idea?

Finally, let us do a rapid-fire take on some of the investible themes and ideas in the market today.

ESG has different meanings to different people, be it from excluding tobacco and gambling from the index, to those companies and sectors which will have a positive social or environmental impact. To this end, some of the largest investible themes which funds cater to in the ESG space include:

  • Sustainable Energy (which we covered in a three part series: Part 1, Part 2 and Part 3)
  • Sustainable Agriculture/Agribusiness
  • Healthcare Innovation and Impact
  • Water

Disruption is a diverse theme, covering everything from pure-technology disruptors to businesses creating emergent business models in established industries – I am reminded here of a fund manager we know well discussing a disruptor in an agricultural sector which has barely changed for over 100 years. Disruption itself is a theme, but there are also funds touching on:

Many managers have bespoke themes, constructed out of the “best ideas of larger ideas”, such as circular economies, resource efficiency, cybersecurity, e-commerce and much more.

This is not an exhaustive list and that is what is so compelling about thematic investing: there will always be another idea.

The marriage between an idea that appeals to an investor and their investment thesis, and one which can further be actioned and executed by an investment manager, is a powerful force within any portfolio to suit whatever your “why” may be.

The views expressed in this article are the views of the stated author as at the date published and are subject to change based on markets and other conditions. Past performance is not a reliable indicator of future performance. Mason Stevens is only providing general advice in providing this information. You should consider this information, along with all your other investments and strategies when assessing the appropriateness of the information to your individual circumstances. Mason Stevens and its associates and their respective directors and other staff each declare that they may hold interests in securities and/or earn fees or other benefits from transactions arising as a result of information contained in this article.