Private View Blog: What is wrong with private banks' approach to thematic investing?
In traditional wealth management institutions, themes are most of the time simply added into the client’s portfolio as a sum of one-off ideas, depending more on the marketing success of the sellers, than the true benefits in terms of risk diversification and expected excess return for the clients. The time is ripe for truly independent advice on thematic investment. Time to “Get up, get into it, get involved,” as James Brown put it back in 1970.
Imperfect future
The acceleration of trends we see in our times is phenomenal: the digital revolution is impacting every corner of our lives, the energy transition has knocked at our doors and environmental, social and governance consciousness is in full sway. Disrupting companies are challenging established firms or creating new markets. Tough periods of renaissance are not an easy ride from the investment perspective, as they broaden the range of possible outcomes.
Indetermination rules our future. Technologies, plus economic and social trends, are planting the seeds, but the landscape will be swampy and complex. Markets can be unfriendly, however appealing the theme is. Stocks linked to those themes which were ‘top of the pops’ during the pandemic times of 2020 – such as digitalisation, healthcare and energy transition – ended up massive underperformers in the first half of 2021. It is fast becoming clear that change needs to be managed with discipline and strong judgment in portfolios.
Moreover, there is a nagging agency problem. Most thematic investments are driven by marketing campaigns and product push initiatives led by institutions that have a vested interest in the products they sell. This can lead clients to be loaded with thematics that are highly correlated. An honest recognition of these pitfalls calls for an independent, pragmatic and versatile approach to the key markers of disruption and how they are represented in the portfolio.
Learning from current thematic practices
It takes more than conviction to succeed. The common practice of thematic investing is 80 per cent investment storytelling and 20 per cent portfolio relevance. Thematic investment decisions are more emotion-driven than investors realise. Most investors’ biases are magnified with thematics: overconfidence (justified by the price momentum), regret (fear of missing out), survival bias (mistaking luck for skill) and risk aversion bias (selling winners, keeping losers).
Huge marketing and sales efforts comfort these biases and influence the decision. Because the essence of thematic investment is momentum, only portfolio discipline and authentic independent advice can trump these biases.
Nice thematic stories can hide similar risk drivers (measured for instance by the Principal Component Analysis of the variety of current investment thematics). It is not only important to look at the disruption narratives, but at the chain reaction of changes. The proliferation of digital tools has amplified the storage problem, increased energy demand, and created digital waste.
The energy transition towards renewables also means huge initial demand for energy to extract, transform and distribute energies. In another example, quantum computing, virtual and augmented reality technologies and ‘future of money’ themes involve common major actors and thus can lead to poor portfolio diversification.
Non-listed assets are not, or barely, represented in popular thematics. The selection approach is different from listed equities. The latter are driven by the optimisation of return, bearing in mind certain risk parameters. The goal of private equity or venture capital, in contrast, is to achieve maximum profits for a limited number of winners to compensate for the demise of the losers. As the key success factor is survival of the fittest, risk for the investor and the due diligence involved are radically different.
Independent view needed
The recognition of these pitfalls is begging for a new approach, closer to the clients’ needs and expectations for their portfolios. More private wealth clients sense they are in an asymmetric position. Understanding the full, transparent picture and the possible implications to their specific portfolio, are paramount to the successful implementation of thematic investment. All of this points to the benefits of using independent advisers that have developed a dedicated selection process and fair monitoring tools to help private wealth clients regain control and prosper. Otherwise, disgruntled investors will be looking to demand what James Brown, in his 1973 song, called ‘Payback’ from their wealth managers.
Didier Duret is a non-executive chairman on the board of directors of Omega Wealth Management SA , and member of the investment committee at Halkins Investments LPP. He holds several independent advisory positions at private family offices and foundations
