Investment themes like crypto, energy, climate change and autonomous cars have all generated a lot of interest in recent years, but while some are long-term trends others will merely be a flash in the pan.
Ultimately there is no perfect formula or list of characteristics, Christopher Gannatti, head of research in Europe for WisdomTree Asset Management said.
One thing investors can make sure of however is that there is a broad, commercially viable investment case behind the theme. If not, funds could be left with a very narrow investment universe, creating issues of diversification and portfolio concentration.
Gannatti highlighted hydrogen as a case study for this, a theme that gained a lot of momentum in 2020 due to its appeal as an alternative energy source to fossil fuels.
He said had a fund group launched a hydrogen exchange traded fund (ETF) in 2020 “the returns would have gone straight to the moon”, but in 2021 it would have been the opposite with returns coming off the boil quickly.
There are only a handful of companies dealing purely with the production of hydrogen, meaning that if they struggle there is little else for the index to fund in.
But this is not the only concern. Timing is also a key consideration around themes. A trend could be a long-term winner but it could not be the right time to buy.
Sticking with hydrogen, currently it is not clear whether it will be the environmental solution it is hoped to be, with some 80% produced in a carbon intensive way, according to data from the International Energy Agency.
This has come to the fore this year, impacting the returns from these companies. “The world got too excited too soon,” Gannatti said.
Clean energy as a broader theme has a lot more certainty long-term though, with the background of government intervention on climate change and focus on the financial industry on environmental, social and governance factors (ESG), but Gannatti said it was important not to get caught up in the hyped niches within themes.
Aanand Venkatramanan, head of ETF investment strategies at LGIM, added that it was essential to delve underneath the excitement of a new area before investing.
He said: “One of the first questions we ask is, ‘is it bringing about a structural and foundational change to our lives, to our work or society? Is it bringing about efficiencies that were once unthinkable, not just doing things differently like making it mobile phone friendly?”
Providing solutions to global issues is one of the ways to have longevity, he said, but even then, it does not mean that every company doing this will be a success.
Steve Wreford, manager of the Lazard Global Thematic Fund, demonstrated this via Zoom, a “Covid winner”, because it provided an immediate solution to the communication issues companies faced during lockdown. Shares rose around 403%, or more than five times, in 2020.
“Short-term investors can be excited by Zoom because clearly we're all going to be doing more video conferencing. But the structural, thematic investor in us says, ‘Okay, let's just think about that market for video conferencing. How many competitors are there? Quite a few,” Wreford said.
As well as competition, the longevity of the company has been called into question now that hybrid working has become the norm, as the manager said video conferencing would likely become part of a free, standard software bundle for companies.
Instead, he bought Microsoft rather than Zoom because it offered its own online conference app – Teams – as part of a much broader software offering, which could make it a more dominant company in the coming years, he said.
In terms of identifying an initial thematic idea, Tom Riley, head of global thematic strategies at AXA Investment Managers said that one of the indicators of a long-term theme was a “step change”, in the industry’s wider adoption and overall growth rates.
For example, Riley said that the firm decided to launch the AXA World Funds Framlington Robotech fund because the industry’s growth rate had doubled to 12% post the financial crisis. This combined with the wider adoption of technology generally meant that there was a broader opportunity set available as well.
“It was as a result of recognizing the step change in industry adoption that we decided to launch the robotics portfolio,” he said.
This initial conversation about whether robotics was a long-term theme began in 2012, when Riley said the firm noticed the spike in growth. The fund itself was launched in 2015, with three years dedicated to establishing the theme’s validity.
Performance of fund vs sector and index since launch
Source: FE Analytics
Since it launched the fund has made 158%, more than double the MSCI ACWI returns (79%).