Thematic Investing Is Showing Cracks

Sebastien Callebaut -

According to a recent report from JPMorgan, the attractiveness of investing in thematic ETFs that target diverse topics like renewable energy, innovation in developing markets, robots and space exploration does not benefit the end investor in the long run.

  • In recent years, thematic investment has exploded, with assets invested in disruptive themes tripling in the last two years
  • The bank examined 1,000 thematic funds with data spanning the last 16 years and discovered that they underperformed global equities by 1.6%
  • High fees of more than 1%, as well as buying "hot" stocks at high prices, are to blame for the underperformance

"[...] thematic funds get launched and attract a lot of inflows when certain themes become 'hot.' This suggests that thematic funds pay high prices for the stocks they select as they buy companies in sectors that fit the hot theme and where the theme is fully priced in," JPMorgan

Environmental, Social And Governance Bubbles

Another big trend in global investing is environmental, social and governance investing. One of the main goals of ESG investment is to redirect capital destined for dirty companies towards cleaner ones. Investors often suppose that these companies are better geared to evolve in future environments. They also argue that these companies should fare better as regulation increases the burden on so-called dirty companies.

"[...] bubbles tend to come not only with a flood of money but also a strong narrative about opportunity."

"Clean-energy stocks tripled because speculators thought not only that they were doing the right thing, but that the shift away from fossil fuels would be very profitable."

"It’s hard to argue that for ESG more broadly, although supporters often argue that their measures help identify risks missed by traditional financial statements." James Mackintosh for the Wall Street Journal

This underperformance can be seen in the graphs here under. The returns of the iShares Global Clean Energy ETF (ICLN in blue) are shown next to the iShares U.S. Oil & Gas Exploration & Production ETF (IEO in red).

Over a 2-years time period, both ETFs have more or less the same performance.

But if you started investing in ESG themes around a year ago, you would have lost 40% of your investment while oil & gas producers would have returned 80%.

BENCHMARK'S TAKE

  • Thematic funds have attracted large inflows in recent years as both institutional and retail investors were attracted by the early successes of this ensemble of stocks
  • Yet, as for many investing strategies, alpha is hard to maintain over the long term certainly as investors start to pile into the trade
  • After a while, the bubble fizzles out and the returns of this stock basket traces back to the markets' averages

Disclaimer

Please note that this article does not constitute investment advice in any form. This article is not a research report and is not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. There is always the risk of losing parts or all of your money when you invest in securities or other financial products.

Credits

Photo by Dimitry Anikin on Unsplash.