Thematic investing is widely regarded as an exciting, potentially very lucrative investment approach. However, it is not without its critics. The skeptical observations that some investors and fund managers make about thematic investing certainly have merit, and should be taken into account by those who choose to use this strategy. By being careful to avoid these potential pitfalls, investors can improve their investment choices and build stronger portfolios. The critics of thematic investing identify four main problem areas. They argue that these disadvantages can prevent the strategy from truly delivering on its promise. These are as follows:
1) It’s Not Always Practical, But More Theoretical
Fund managers can easily get caught up in their idea of what will be the next big trend, rather than analyzing the actual movements of the markets to make investment decisions that are based in reality. In addition, these thematic theories, in the hands of the wrong fund managers, can end up focusing on short-term fads, rather than long-term economic projections. Investments based on such faulty (or even deliberately misleading) thematic analysis can lead to losses and diminished portfolios. In short, thematic investment can easily foster both misinformed investment and dishonest wealth management practices. Investors thus need to take great care as to which wealth advisors they choose to trust.
2) Risks of Concentrated Individual Stock Selection
Diversity is an important quality in a successful stock portfolio. Thematic approaches can tempt investors to lose sight of the benefits of diversity and opt instead to put too many eggs in one basket. This can lead to major financial fallouts. Look at any historical example of how popular investment trends have resulted in bubbles that ultimately burst and caused both individual and macroeconomic ruin. While choosing thematic approaches in some cases, investors should still aim to maintain a healthy and diverse portfolio.
Thematic investments – whether direct or undertaken through vehicles such as exchange-traded funds (ETFs) – can be volatile, especially if the investment is too narrow and concentrated. Again, the fund manager needs to strike a careful balance between identifying strong trends and maintaining a diverse portfolio.
4) Market Timing
The success of thematic investing depends heavily on an investor’s accurate reading and prediction of market timing. Put simply, the investor – or the wealth manager working on their behalf must be able to identify good entry and exit points for their investments. Unless you buy low and sell high, as you would with any other investment vehicle, thematic investing won’t offer the outstanding results you have been promised. It is very similar to any other investment strategy in this sense.
Nour Private Wealth (NPW) is a Canadian company with a team of wealth managers servicing clients across seven provinces. For more information on thematic investing and other forms of wealth creation and preservation, contact us today and speak to one of our wealth advisors.