Press release

Trending theme investments – two side of the same coin

Thematic and trend-driven equity investments are very popular. However, in spite of all the understandable euphoria, investors should also be aware of the risks involved, says Christian Schmitt, Lead Portfolio Manager of the Ethna-DYNAMISCH.

As attractive as it may seem at first glance, there are always two sides to the proverbial coin. This is also the case with so-called thematic investments, which have enjoyed steadily increasing popularity among investors for years and have become indispensable for both passive and active investments. Here, too, the advantages seem obvious and compelling at first. The basis of thematic investments are always economic, technological, social or political trends, which are often summarised under so-called megatrends. Megatrends, in turn, describe significant, sustainable changes in our world that are already clearly evident today, but will also continue for many years or even decades into the future. There is no doubt that technological developments such as automation, digitalisation or e-mobility will accompany us for a long time to come, as will demographic change or the development of renewable energies. The concrete list of corresponding megatrends can be expanded almost at will. All of these megatrends have their legitimate, often even scientifically substantiated, raison d'être so they cannot be argued away. So, what could be more obvious for investors than to invest in those companies that participate directly in these proven trends?

At first glance, the positive association of thematic investments and megatrends seems to be a killer argument against all critics. So, let's take a more differentiated and objective look at the connection. Basically, equities are an investment in a company; the price traded on the stock exchange establishes the link between the stock and the company via the valuation. This understanding brings us directly to an important point. Themes or megatrends only try to establish a link to the company, but say nothing at all about the valuation of the stock. As even the best company in the world can be a bad investment if you pay too much for it, the valuation is by no means irrelevant for investment decisions. Conversely, the current valuation of a stock depends heavily on its future growth. As this growth is by definition subject to a great deal of uncertainty, any indicator that helps to reduce this uncertainty should be welcome. Accordingly, linking corporate development to a megatrend can provide valuable guidance and a structural growth driver in the context of valuation. However, even in this case, uncertainty always remains as to whether the respective technology or the company's concrete product solutions will continue to benefit from the anticipated change in the future.

This is precisely where specialised thematic funds and, in particular, thematic ETFs come in. The more fast-paced an identified growth field is or the further in the future it lies, the more uncertainty there is surrounding the potential success of an individual company. Therefore, it makes all the more sense to put together a portfolio of as many companies as possible that could potentially benefit from the megatrend, and to invest in them. The other side of the coin is that an evaluation of this type of thematic portfolio becomes infinitely more complex - if it is even possible at all. In addition, a review of the single stocks contained in the share basket is unavoidable. Only in this way can investors form an impression of how close the stocks in the portfolio actually are to the megatrend. For more specific themes such as space exploration, for example, there are hardly any focused, exchange-traded companies. If the themes are too general, such as simply innovation or gender equality, almost anything can end up in the portfolio.

A look into a thematic portfolio is also worthwhile in order to check the liquidity of the single stocks. In practice, this is also a point that should not be underestimated, as with ETFs in particular, the liquidity management of the single stocks within the ETF is different from that of actively managed funds. Passive products simply replicate the ‘market’. What can result in strong price influences on single stocks even in the case of large, established indices - for example in the case of index adjustments - can become a price-dominating factor for smaller-capitalised single stocks. This liquidity risk is even initially directed upwards in the case of highly sought-after trends and can act as a real price booster. However, after that it is just as likely to move in the opposite direction. Moreover, liquidity affects not only the investors directly invested in the thematic ETF, but also the investors directly involved in single stocks. Therefore, the question of who the dominant shareholders of a stock are becomes an important aspect in the risk management of single stocks. This perspective becomes all the more important in light of the fact that a megatrend that is already covered by various thematic funds can certainly no longer be called an insider tip. This, in turn, can quickly lead to excessive expectations and ambitious valuations, which should be weighed accordingly in the risk/reward consideration of the investment.

In general, a differentiated risk/reward assessment should be at the heart of every investment. This also applies, perhaps even more so, to thematic investments. Even if it may currently seem that theme-based investments are particularly innovative, they are not new. They have recently become very popular again, above all due to the success of some established thematic funds and an increasingly broad range of thematic ETFs. So popular, in fact, that an increasing number of portfolio managers are starting to structure their portfolios top-down not only by region or sector, but also by selected themes. In keeping with the motto ‘facts tell, but stories sell’, this is not a bad idea, because the underlying investment idea becomes much clearer and more comprehensible for the client. Nevertheless, one should not forget that virtually all major, and also minor, share bubbles of the past had a strong connection to individual themes. They were also megatrends of technological progress. No matter whether it was the US railway at the end of the 19th century; cars, telephones and electricity in the 1920s or the internet at the end of the 1990s - the story was always right and technological progress made a lasting improvement to people's lives. Similarly, enormous price gains were recorded in a short period of time. However, unfortunately, parallel to the stock market boom, the valuation always went off the rails. So, the disappointment after the abrupt end of the boom was equally severe.

In summary, the two sides of the same coin accurately reflect the ambivalence of thematic investments. It is true that thematic investments have power. And thematic investments have a strong foundation in the underlying megatrend. But it is also true that thematic investments harbour their own risks over and above the general equity risks, of which one should be aware. In the Ethna-DYNAMISCH, the most offensive multi-asset fund of the three Ethna Funds from ETHENEA, we therefore have a thorough approach. Trends and themes are, in our view, good points of reference to underpin structurally sustainable growth within the framework of a fundamental equity analysis. When viewed objectively and holistically, however, they are also a proven indicator for identifying potential risks on the equity markets. As we want to offer our clients risk-controlled access to the global equity markets, we therefore benefit twice over from an intensive examination of trends and themes.