Investors in the new generation of passive ‘thematic’ funds may soon pay the price for an overweight exposure to growth factors as the market rollercoaster loops-the-loop if a new study from Wellington Management is on the right track.
Wellington multi-asset portfolio manager, Brian Garvey, and associate director of multi-asset risk oversight, Manny Hunjan argue in the note that almost all of the recently launched index products chasing “singular innovative or disruptive” trends remain skewed to growth.
“… these indices are generally constructed after confirmation of strong performance from the underlying theme and with the benefit of hindsight into the previous cycle’s business environment,” the analysis says.
“More concerning to us, though, is that ‘underneath the hood,’ the majority of thematic indices are heavily levered to the same market factor that performed well over the last cycle — namely, growth.”
While investors have been queuing up to hop on the latest passive theme ride marketed under labels such as ‘robotics’ or ‘disruptive technology’ or ‘smart cities’, the Wellington study says the high-risk concentrated growth strategies also fail basic diversification safety tests.
Even creating a multi-theme experience constructed with the current batch of passive trend-chasing products would probably not add much diversification to the mix given the overall growth bent.
“The absence of passive thematic indices with a more balanced factor footprint could present a formidable challenge for allocators looking to gain exposure to more niche opportunities that could potentially benefit from shifts in factor performance leadership,” the paper says. “And, returning to the point on diversification, we believe allocators would be hard pressed to create ‘factor-diversified’ thematic portfolios by leveraging only existing passive thematic indices.”
Garvey and Hunjan suggest that forward-looking thematic allocations can improve portfolio risk-adjusted returns if investors focus on diversified exposure to out-of-favour sectors poised for a structural rebound.
However, the ‘Wanted: A better definition of thematic investing’ report says the increasingly popular backward-facing index strategies likely won’t provide much fun.
“… history suggests that one of the worst strategic asset allocation decisions is to extrapolate the dominant trends of the past decade into the next one.
“Our concern is that the success of many existing passive thematic indices is at least as much a function of the macroeconomic environment of the recent decade — one marked by secular stagnation — as it is of any particular fundamental insight.”
With global economic backdrop changing rapidly investors on the passive theme train might be in for more a scare than a thrill: no money back.