Is thematic investing a smart move?

Think carefully before you buy shares in a thematic exchange-traded fund (ETF). It might seem you’re making a smart move to capture investment trends that might otherwise be elusive. That’s what the marketing spiel will say and that’s what you’ll tell yourself (then again, whoever made an investment thinking it was a dumb move?). Chances are, however, you might just as well be putting money into a fund that tracks an index for growth stocks. When it boils down to it, that’s all thematic investing is – growth-stock investing dressed up for the diversified and inclusive 2020s.

Granted, I write this as a contention and not as a firmly held view based on solid research. Nor am I hostile to the notion of thematic investing in general or of using ETFs as a means to put it into practice. On the contrary, I stick to what I wrote two years ago (‘The Heineken Factor’, IC, 19 February 2021) that ETFs are the Heineken lager of investing – they reach the parts that other securities cannot reach, perhaps the most important part being thematic investing.

And I am hardly alone in this view. A survey commissioned by specialist ETF provider HanETF found that 42 per cent of almost 1,100 investors questioned had capital in thematic ETFs. That was nearly the same as the proportion who used ETFs to track a broad stock-market index and it was seven percentage points more than the fraction of the 1,100 who had money in sector-tracking funds.

Meanwhile, research from index provider MSCI concludes that there really is a distinction between growth stocks and thematic stocks, while thematics might be the better performers. At least, a quasi-index of leading thematic stocks, put together by MSCI and drawn from several themes, performed better than a global growth-stocks index in five out of the six years 2017 to 2022.

MSCI compiles many thematic indices under such headings as ‘ageing society opportunities’, ‘the blockchain economy’, ‘disruptive technology’; you get the idea. Implicit in these indices is the notion that they capture industrial trends that will shape the future to the extent it can be discerned. As such, they must contain growth stocks, even if some of their components are more like speculative situations. Put another way, some are the growth stocks of the future, as yet to do anything so mundane as generating a profit; others are the conventional variety with a record of steadily rising sales, profit and earnings.

Nor does it help clarity that the distinction between growth stocks and thematic ones isn’t always obvious. To illustrate, MSCI uses a comparison between two global greats of healthcare, Denmark’s Novo Nordisk (DK:0TDD) and Johnson & Johnson (US:JNJ). According to MSCI, Novo Nordisk, which makes most of its profit through diabetes treatments, appears to be the better growth stock. Its share rating beats J&J’s on several standard measures of growth, such as forecast earnings growth and sustainable growth rate. However, J&J, still best known for Johnson’s Baby products, looks the better bet for thematic growth. Its shares feature in four of MSCI’s thematic indices, including ‘ageing society’ and ‘digital health’.

Fair enough, but some investment themes look a better bet than others as future growth machines. Take ageing society. This backs the idea that there is money to be made from the decline of the baby boomers as they slide from their Harley Davidsons into a life of private residential care, supported by Zimmer frames and copious amounts of drugs (the medicinal sort).

The reality may be different. The drain on the public purse of meeting the huge unfunded costs of ageing will leave little room for private profit. That much is implied by the performance of iShares Ageing Population (AGED), a London-listed ETF that tracks another ageing society index. Since its launch in September 2016, the fund’s total return is just under 40 per cent with the share price at 550p. Over the same period, the total return for the MSCI All-Country World index is 72 per cent.

In a way, what else would you expect? After all, the AGED fund tracks its index via 376 holdings, which focus on the US and on the healthcare and financial sectors, but also have a global reach. In other words, the theme is represented by a broad-based index from which it would be almost impossible for sustained market-beating returns to emerge.

Meanwhile, some investment themes falter because they are too narrow. That may be the fate of HanETF’s Medical Cannabis and Wellness (CBDP), a bet on the potential of cannabinoids to treat a range of disorders, especially epilepsy. Little more than a year from the fund’s launch in January 2020, its share price had more than doubled. However, at its current 398p, the price is down 41 per cent from its launch. Sure, the price may get another period in the sun. But the fund tracks a theme so specialised and via just 20 holdings – three of which account for over half its investment – that volatile performance is almost baked in.

But none of the eight ETFs in the table, which are those mentioned when this column tackled thematic investing two years ago, has posted a performance that says ‘wow’. Granted, it may still be too early to judge. Almost by definition, thematic investing peers into the distance where the outlines are dim and the shapes are blurred; success, if it arrives, will be a long time coming and patience is a prerequisite. So it is encouraging that the longest-established ETF in the table, iShares Global Water (IH2O), is also the best performer. Since its launch in March 2007, the total return on its shares is 191 per cent compared with 177 per cent for the MSCI All-Country World index.

The conclusion may be that thematic ETFs perform a useful function, but that does not make all of them worthwhile. Investing in them requires the scepticism and criticism investors must bring to all opportunities. Sometimes, the question may be not whether they offer growth by another name but whether they offer sectoral investing in another guise; majoring on two or three sectors and dressing it up as a theme.

Even that does not necessarily make a theme bad. Take Wisdom Tree Battery Solutions (CHRG), which aims to capture all points in the value chain that makes energy storage. In practical terms, that means a heavy exposure to two sectors: industrials and materials. Together, these account for over 60 per cent of its portfolio, which means big holdings in dull-but-worthy names such as German giants BASF (GER:BAS) in chemicals and Siemens (GER:SIE) in engineering. Simultaneously, however, the ETF offers the attraction of 25 per cent of its capital in Chinese stocks, some of which would otherwise be inaccessible to private investors.

Before thematic investing became fashionable, it was confined to broad aims such as growth or income investing. Hence the inclusion of Wisdom Tree Global Quality Dividend Growth (GGRP) in the table. This ETF is remarkably similar to iShares MSCI World Quality Dividend (WQDV), which we suggested was a possible route to extend the reach of the Bearbull Income Portfolio outside the UK (20 January 2023). Sure, the 2.3 per cent dividend yield on the Wisdom Tree fund is short of what’s generally expected from income investing. Then again, with 57 per cent of its portfolio in US stocks, Microsoft (US:MSFT) and Apple (US:AAPL) as its biggest holdings and 20 per cent of the fund in the IT sector, we might expect nothing more. Besides, lack of income is compensated by the certainty of dividend delivery plus a performance that leaves the FTSE All-Share index behind. Since the fund’s launch in November 2016, its total return stands at 101 per cent compared with 46 per cent from the All-Share.

Additions to the Bearbull Income Portfolio

But there is also the matter of conventional additions to the Bearbull portfolio, as discussed last week. One name cropping up was supermarkets operator J Sainsbury (SBRY), which, it turns out, has an interesting new shareholder. Joining the Qatar Investment Authority (14.3 per cent of the equity) and Vesa Equity Investment (10.0 per cent) is family-controlled conglomerate Bestway. The UK’s second-biggest foods wholesaler has bought a 3.5 per cent stake, although it probably can’t bid for Sainsbury for six months.

Even so, with 28 per cent of its shares owned by investors who might be labelled ‘non-passive’, Sainsbury is some way to being in play. That might be another way of saying the downside on its share price – at 262p, up 50 per cent from its autumn low – is limited, while there is a 5.3 per cent dividend yield to be going on with. Shares in its closest rival, Tesco (TSCO), offer half a percentage point less in yield but a bit more dividend cover and, in terms of operational metrics, slightly better figures than Sainsbury. Oddly, there has never been a food retailer holding in the Bearbull portfolio. Now might be the time, but it’s a toss-up which of these two it should be.

Some of the other names hoving into view are the usual suspects, such as housebuilders and construction-facing operators such as Speedy Hire (SDY) whose time may not yet be here. Shares in another candidate, bowling alley operator Hollywood Bowl (BOWL), may have bounced too far – at 265p, they are up 64 per cent on their 12-month low.

That still leaves soft-drinks supplier Britvic (BVIC) and speciality chemicals maker Victrex (VCT), offering a combination of high-quality operations and acceptable dividend yield – 3.7 per cent and 3.3 per cent, respectively, based on their forecast payout. Call me dim, but I’m still not sure why Victrex’s share price has fallen so far – at £18.02, 48 per cent below its five-year high. Maybe it’s largely about a share rating that needed to fall to earth, but it’s one to be discussed next week.