Why you should avoid thematic funds [video]

In this video you'll learn: 

• what a thematic fund is;
• why thematic funds have become so popular in recent years; and
• why investors should avoid thematic funds. 

Transcript

Robin Powell: A type of investment fund that’s become increasingly popular in recent years is the thematic fund.

As the name implies, these are funds that focus on a particular investment theme. It might be biotechnology stocks, for example, or firms that will benefit from more working from home.

Alternatively, it could be an emerging economy like Thailand or Malaysia.

As investment strategist Nicolas Rabener explains, thematic funds can be very appealing to investors.

Nicolas Rabener: Another way of defining thematic investment is calling it performance chasing with a narrative, and unfortunately, retail investors, as institutional investors, do tend to chase performance, which makes thematic investments so seductive, because, on the one hand, you have a great story, so, the rise of artificial intelligence, and you have a bunch of stocks that effectively have generated fewer returns, and of course, it’s very easy to fall into that and subscribe to that.

Robin Powell: The fact that these funds have a narrative and are therefore easier to market also makes thematic investing attractive to fund management companies.

But there’s another important reason why the industry likes them.

Nicolas Rabener: The second component for asset managers, why they do like thematic investments, is because they can charge higher fees. So if you look at the fees of thematic investments today they are around between fifty and seventy-five basis points, versus indices like the FTSE 100, it’s between zero and thirty basis points. So because it’s a bit more of a complex area, asset managers can charge for that and that of course is to their liking.

Robin Powell: So, how do thematic funds tend to perform? Unfortunately, the evidence is not very encouraging.

Nicolas Rabener: There’s a lot of research including our own that indicates that performance chasing is negative and effectively means that investors underperform compared to a simple index. And the easiest example would be, simply looking for the best performing fund, as of today, that on average, you’re going to underperform with that. And the reason for that is that most of the time when investors enter a certain theme, it has already had a lot of inflows, valuations have peaked and it’s just become expensive. Then it does tend to correct after a certain amount of time and the best example would technology stocks in 2000, where effectively everyone wanted to be invested, but at some point, there weren’t a lot of natural buyers left, valuations were expensive, and therefore on a going-forward basis, investors underperformed.

Robin Powell: In summary, then, thematic investing is essentially performance chasing — jumping on a bandwagon when it’s too late to benefit.

Investors are usually better off investing in plain-vanilla index funds.

Or, if you really want to try to outperform the market, you could consider factor investing.

But don’t be seduced by the latest investment themes.