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Should investments be defined by theme rather than industry index?


The extent to which asset management depends on classification is remarkable. The entire edifice of modern investment funds is built on what many see as a dated way to look at investment choice.

Asset managers divide up the world using industry and index classifications built for institutional users, forcing retail investors to struggle with odd acronyms.

I’ve lost count of the number of Britons who say they invest in UK shares via a fund that tracks the FTSE 100 or uses it as a benchmark. The FTSE is, of course, far from being a surrogate for the country’s economy.

Sector definitions are also tenuous. Take technology and industrials. The former suggests semiconductors and software while the latter implies valves and whizzing parts and steam. That distinction is breaking down as industrials begin to look and feel like IT businesses.

More to the point, many people now ask why investments cannot be defined by outcome or a theme rather than classification.

Our ageing society, for instance, is a trend that can be seen from space. The grey armies of the retired will multiply and that will mean huge demand for certain products and services.

How to capture this via a signal sector fund? Cue the thematic approach.

In Europe especially, some asset managers have built fearsome franchises with consumer-friendly funds that speak to thematic trends. Pictet and CPR, part of Amundi, have funds addressing themes, from our warming planet and robotics to ageing societies and food.

Issuers of exchange traded funds have joined the scramble. Thematic indices and accompanying ETFs have hoovered up relatively large sums of money.

LGIM’s acquisition of the thematics-focused Canvas operation from ETF Securities, for instance, was partly spurred by the success of the latter’s robotics funds, which were quickly imitated by rival iShares.

Additions to the thematic armoury include cyber technology and orphan drugs, as well as ecommerce trackers from arrivals such as HanETF. Arguably, we had already seen this thematic battle take shape in the US and Europe with blockchain-themed ETFs.

The growth in thematics and the investor enthusiasm for the approach presents new risks.

Philosophers have long accepted that ontology — the definition and nature of categories and concepts — is a vital source of analysis.

In asset management this translates into whether a business is true to the category. Is putting Microsoft shares in a basket of blockchain service providers relevant?

A related question touches on outcomes. A group such as Microsoft may be ontologically connected to cyber defence but surely most of its cash flow derives from selling Office and other software.

Ageing as a thematic also calls to attention the strengths and weaknesses of super-sector ideas. Putting drug development businesses in a basket of shares alongside, say, wealth managers makes sense on one level: both benefit from the mega trend.

Such super sectors, though, may end up drowning out the signal (we’re all ageing) against the noise of daily reporting and sub-sector specifics (are ETF managers cutting into asset manager margins?).

My fear is that all these questions of focus, impact and correlation with a signal require constant intervention. In this respect, active managers have a huge strength.

Their manager can simply declare: “Businesses X and Y fit my definition of a thematic but I could change my mind depending on the facts.”

What matters is performance against the benchmark. No one will punish them if they weight a stock that may not be as relevant but which then quadruples in value.

Passive fund managers running thematics will encounter many more risks around definition and focus.

My sense is that they need index providers who are more active in how they police what is in and out of an index.

These index companies need to be experts but specialist index developers such as Robo Global, which provides the intellectual property for ETF issuers, are the exception not the rule.

In the absence of such specialists, my fear is that many thematic ETFs, while popular, may end up being unfit for purpose — and mere marketing flashes in the pan.

David Stevenson is editor of etfstream.com and is the Adventurous Investor columnist for FT Money



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