Sectors make sense for investors, not themes
Damn the rule we built into this column precluding me from buying funds I recommend for 30 days lest my ramblings move the Dow or the trillion-dollar bond market. I mean, as if. While I’m delighted that readers may have enjoyed their equity and fixed income returns over the past month, can prices fall again please until I’m set myself?
Kidding. And who knows which way markets are heading? We’re only a fortnight into the year and are not inane tennis pundits extrapolating the “vital opening game”. Plus I need some time to ponder the rump of cash I want to put to work. Once I’ve overcome the bureaucratic forces of evil trying to stop me transferring it into a self-invested personal pension (Sipp), I said last week that I’m keen on a sector fund.
This prompted hundreds of emails asking, why a sector? Readers have suggested a few thematic ideas instead, which is probably my fault since I wrote about liking the metaverse. In my experience, however, thematic investing is akin to immortality or total honesty with your spouse. Great in theory, but flawed in practice.
I’d go further and warn that investors should avoid thematic funds. I should know, as ex-head of thematic research at a global bank and having launched a fair number of such funds in my days in asset management. Here is the problem. As I said, the theory is fine. Identify a theme, be it the rise of Asia’s middle class or the reshoring of manufacturing. Invest in assets which will benefit, make a killing.
In practice, however, one of three things happen. Perhaps a clever analyst spots an original theme before anyone else. He pitches it to the sales team who have never heard of it or are too busy flogging the hottest product in the market. They say — correctly — that clients will not be interested.
Alternatively, you persuade sales that the theme is a winner. But this has taken half a year. Add months for the requisite signoffs and usual hoops to jump through when launching a fund. Then your distribution network needs convincing. By the time you have any scale, the underlying securities are no longer cheap — the theme has long since run its course.
The third and most common way thematic funds are born is when someone in sales or product development has read about a hot theme in an airline magazine, or someone at golf was banging on about the “circular economy”. Everyone is bullish, and the race is on to bring a product to market.
This is fine for everyone but us poor sods who invest at the peak of the theme, just before prices correct. I’ve done a lot of analysis on the money-weighted performance of thematic funds, which weights returns by the date and size of flows into them. Little money is around at the start to enjoy the serious gains. Most rushes in near the top, and then suffers a loss.
On this basis, most thematic funds destroy more value than they make. If there is a lesson to take away here, it is the same for all investing. Buy when no one is talking about a theme and sell once everyone is. Easier said than done as most funds are launched only when a theme is exciting enough, and by that time it’s too late.
Maybe I’m teaching readers to suck eggs. Despite the hoo-ha, thematic funds remain a side show, accounting for just 2.5 per cent of worldwide equity assets under management, according to Morningstar data. That has been a good call given that only two (“cyber security” and “social”) of the 33 themes tracked have outperformed the S&P 500 over the past five years.
What is more, a third of thematic funds launched a decade ago have not survived. That’s no worse than mainstream funds to be fair, but ironic for a strategy sold on long-run trends. Nevertheless, all the above is my long-winded answer to the question of why I prefer a sectoral view (or even a geographic one for that matter — a topic for another day perhaps).
You know where you are with sectors. There’s historical data aplenty on how they perform versus this or that index, the drivers of returns, and valuations. Buying a sector also means you don’t have to mess about with stockpicking, which is a crap shoot anyway. Sure, the spread of returns is narrower with sectors, but there is still a 60 per cent difference between the best and worst funds over five years.
I also like how sector returns aren’t as correlated as major equity markets — roughly a third less, reckons Ekins Guinness, a sector rotation manager. What makes bank shares hum (interest rates) is a mile away from the drivers of energy stocks (oil and gas) or consumer staples (pricing power) or technology (bullshit). This favours an active approach and seems easier on my aged brain.
Having said that, I’d love there to be many more sector funds available, especially ETFs. There are hundreds of pharma and technology options out there, as well as energy and precious metals. But good luck trying to invest in paper and packaging, say, or even plain old steel. Come on asset managers — get cracking!
The only two sectors I currently like out of those readily to hand are industrials and finance. The latter because it’s cheap, should perform when rates turn, and there’s fat to cut (expensive bankers). But I’m going with industrials. For starters, cash flow growth is impressive, debts are down, and valuations are attractive.
The main reason, however, has to do with productivity. In last week’s column I mentioned the previous surge in the 1990s. It wasn’t the sexy tech companies that benefited most, it was the bread-and-butter industrials. Fingers crossed it happens again.
The author is a former banker. Email: stuart.kirk@ft.com; Twitter: @stuartkirk__
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