March 2010

THEMATIC INVESTING: the theme teams

Fiona Rintoul finds out what currently drives thematic funds and how to distinguish between managers in the sector
vegetables.jpgSeen by some as a marketing gimmick and by others as a fundamentally different way of approaching equity investment, thematic investing has certainly been gaining in popularity in recent years. Alliance Bernstein has just brought its Global Thematic Research Portfolio to Europe, launching a Luxembourg Ucits III range for the purpose. DWS started to expand the markets in which it sells its eleven thematic funds last year, and Swiss & Global Asset Management began to build its range of eight Julius Baer-branded single-theme funds in 2007. In fact, so numerous are the companies piling into this approach that thematic investing is starting to feel like the new ‘multi-boutique’.

So what is it and why should we care?

Tom Beever, fund manager European equities at Newton Investment Management, says: “It’s the idea that over any economic cycle there are normally just a few key drivers of change that you need to identify to generate strong long-term performance.”

Meanwhile, Pieter Furnee, head of the UK, Netherlands and the Nordics at DWS, puts it like this: “You basically look at the same universe as a global equity manager, but you make different selections.”

Beever should know, as Newton is one of the few firms that employs this approach across its fund range – and has done since it opened its doors 30 years ago.

“Most of the market is focused on short-term issues such as quarterly results,” explains Beever. “The advantage we’ve had is that focusing much more on the bigger picture allowed us to do something quite different from the rest of the market. We might not have outperformed in each quarter, but over the longer period we’ve generated substantial outperformance.”

Newton currently has 15 themes on the go. They are updated regularly and if a theme is deemed no longer relevant it is removed from the list, while new themes may be added. Key current themes include developing economies, population dynamics and earth matters (climate change).

“The idea behind the themes is that they provide a framework by which we think about the world,” explains Beever. “They’re not the be all and end all. They’re not supposed to be prescriptive. In any one portfolio and any given time we may play a handful of themes and the ideas in our portfolios may tie in to more than one theme.”

Following trends
The themes are also not meant to be speculative. They always relate to developments that are already playing out in the world. And they can be as much about telling Newton fund managers what to avoid as what to seek out. Thus, the debt and credit theme, recently removed because it is played out, focused on the idea that in the last decade there was an unsustainable build up of debt in the world and led Newton to be underweight financials and consumer discretionaries. This position has been replaced with a theme entitled ‘all change’, which focuses on the environment following the credit crunch.

As Newton uses themes across its entire range of funds, it runs a mix of benchmarked and unconstrained portfolios. However, other investors who run themes more as a sideline tend to focus on the unconstrained.

At Alliance Bernstein the funds in the global thematic research portfolio are all unconstrained and can, says Jim Ross, senior portfolio manager on the global thematic team, be much further away from the benchmark than conventional portfolios.

“They tend to be chosen by large pension funds pursuing a core-satellite approach and multi-managers who appreciate their low correlation to traditionally managed equity portfolios and their diversification benefits – and can stomach the unavoidable periods when returns are poor, Ross says.

For this reason, Ross believes that the Alliance Bernstein thematic funds are ideally suited to the current environment. “After the credit crunch, people are either moving to passive for beta or to more aggressive active,” he says.

Similarly, both DWS and Swiss & Global report that their thematic funds tend to be used by institutional investors for aggressive active, although DWS’s Furnee says that good performance last year has led some investors to look at the DWS funds in a different way.

“When you have a thematic screen, you are diversifying your equity exposure,” says Furnee. “It’s interesting to have as part of your global equity exposure. We see a lot of private banks thinking about themes.”

The Alliance Bernstein funds focus on just five themes: genomic medicine, cloud computing, climate change, the emerging middle class and heightened cyclicality, an economic theme – and that is a quite deliberate strategy.

“We’re relatively concentrated compared to our rivals,” says Ross. “We believe there’s a sweet spot in terms of diversification. If you have too many themes it’s an invitation to indiscipline. Once you have ten themes you can justify buying anything.”

Although Alliance Bernstein puts research energy into identifying new themes, some themes are not really ‘new’ at all but represent instead a particular take on an existing trend.

“There aren’t that many new themes,” says Ross. “It’s naïve to think that the next exciting thing will carry your performance. We might have a novel take on a theme. For example we have a climate change theme, but we feel that classic plays might have risks associated with them and so a lot of our climate change bets are nuclear.”

Themes are also tilted according to the prevailing economic climate – there isn’t always an economic theme but there is always an economic overlay – and are weighted differently throughout their lifetime.

“You get some people who equally weight themes, but we think that’s a waste,” says Ross. “Opportunities vary throughout a theme’s lifetime, and so we vary our weights.”

And, of course, investing by themes doesn’t mean you can throw all the normal investment disciplines out the window. Stock-picking remains important as does effective risk management.

Like Alliance Bernstein, DWS bases its thematic product range heavily on research. The thematic platform, which is based in New York and has been on the go for ten years, comprises 400 sub-themes and is underpinned by a through-going research effort.

“When the researchers have identified a theme they present it to the portfolio managers, who try to rip it apart,” says Furnee. “If it can go to the next level we then look at whether it’s investable. We have seen that the themes are quite stable because there is so much research beforehand.”

Who eats what, where
A key theme for DWS has been how to feed the world. “We started to look into this five years ago,” says Furnee. “It wasn’t covered by the industry and that’s something we like to see. We built up our own models and did our own research.”

Originally one theme in the Global Thematic fund, this became such a powerful theme that it led to the launch of the DWS Agribusiness fund in 2006, which, having turned in a performance of 72% last year, has garnered a lot of attention and built up assets under management to $3.5bn (€2.5bn).

This fund plays both developing and developed world sub-themes. The developing world story is that as people become wealthier they want to consume more protein. In the West, there is the move towards organic food, which has a bigger impact on land use than non-organic food, and what is called ‘functional food’.

“In the US you can have a gene passport made and it will tell you which foods you should avoid,” says Furnee. “It will maybe become a little ridiculous, but everyone can sense there is a market for it.”

At Julius Baer, the approach to thematic investing is different again. Its eight thematic funds are all single-theme and complete its existing range of active core and emerging-market funds. In general, the thematic funds are used as performance enhancers, though sometimes, as in the case of the Julius Baer Infrastructure fund, there can also be diversification benefits.

“Thematic funds enable investors to focus on specific themes where there is above-average growth,” says Dirk Kubisch, equity product specialist at Swiss & Global Asset Management.

One of the key things that distinguishes the Julius Baer range from other thematic fund ranges, is that not all the funds are managed in-house.

“We identify secular trends and decide whether to play them in-house or to assign an external manager,” says Kubisch. “Given that Julius Baer is a well-known brand name we can approach even very good fund managers who don’t normally manage funds for other investment managers.”

So, for example, the Julius Baer EF Infrastructure fund is managed by Macquarie.

There can be little doubt that thematic investing is on the increase and that it has a certain appeal for investors. “What I like about thematic investing is that the client can instinctively identify the power of the theme,” says Furnee.

But, as with many clever ideas, the devil is in the detail, or, in this case, perhaps more correctly in the research. When it comes to the likes of agribusiness, investors have three choices, says Furnee.

“They can go with soft commodities. They can go with a bandwagon provider out of a marketing department. Or they can choose really researched products.”

©2010 funds europe

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