The seven sins of thematic investing

We believe thematic investing offers investors a compelling opportunity to capture the most important structural changes of our time—but only if implementation is robust. The Lazard Global Thematic Equity team has honed its approach to long-term investing for decades, and we have learned through experience and close observation some of the mistakes investors can and do make.

In our companion paper, “Capturing Structural Change: A Guide to Thematic Investing,” we offer a comprehensive introduction to thematic investing, highlighting benefits in terms of return generation, risk mitigation, and sustainability integration. That paper also noted the importance of robust implementation. Over the years, we have identified many key implementation errors and, indeed, made a few of our own. Unfortunately, we see these errors playing out across the industry to this day, with potentially negative consequences for unwitting investors.

In our view, many of the “thematic” investments available today are little more than slick marketing and may not offer an opportunity to achieve excess returns over the long term. In this paper, we offer our insights as to how to identify and help mitigate implementation of some of the material risks our team has identified in thematic equity strategies. We provide suggested solutions, alongside a checklist of questions to ask managers to help determine if they are committing one of the “seven sins" of thematic investing. Each of these implementation challenges is summarized below.

You can access the full white paper here. 

Sin # 1: Narrative fallacies

In our view, thematic strategies are particularly vulnerable to building themes around slick, but potentially empty, marketing narratives rather than genuine return opportunities. Single-theme strategies are likewise susceptible to narrative fallacies as they create additional incentives for confirmation bias, where investment teams seek out evidence that confirms a strategy’s relevance and ignore evidence that undermines it. We believe these risks can be mitigated by introducing competition for capital across multiple themes.

Sin # 2: Foggy forecasting

Forecasting, particularly as far out as the next decade, is at best imprecise and at worst dangerous. Investors should ask managers where their ideas originate and prioritize sources grounded in real-world experience rather than popular consensus. We source most of our ideas from discussions with companies themselves, as they will be allocating the capital that will drive structural change. Managers should be humble about their ability to predict future outcomes amid unforeseeable risks and be wary of attempts at optimization ahead of an inherently uncertain future.

Sin # 3: Sledgehammer scope

We view generic investment ideas as sledgehammers—simple, broadly defined investment propositions that make an immediate marketing impact but can leave lasting damage to portfolios. Themes that are designed too broadly in scope may not target the actual return opportunity. For this reason, we develop our own proprietary themes with an eye toward isolating what we believe to be specific structural changes that can generate returns. We also permit themes to evolve over time which is designed to avoid obsolescence. Theme design should ultimately be as precise as possible rather than convey a grand vision—and as such, we believe managers should use a scalpel, not a sledgehammer.

Sin # 4: Puzzling purity

Stocks that appear to be valid candidates for a theme might actually have very little relevance. Managers should look beyond simple purity metrics to identify companies that truly stand to benefit from the diverse potential drivers of structural change. Managers should also cross-check for idiosyncratic risk and valuation. Finding the right pieces to solve a thematic puzzle necessitates going beyond the obvious.

Sin # 5: One-trick pony

In our view, having multiple themes is of no benefit if they are all the same underneath the surface. We believe a thematic strategy should try to access multiple sources of return from structural change without permanently embedding a reliance on a particular geography, sector, or style. Sensible portfolio construction should employ diversification across different fundamental thematic ideas.

Sin # 6: Failure to integrate

We observe that managers tend to make three mistakes when claiming to incorporate sustainability into their investment processes: failing to do it, pretending to do it, or doing it badly. We incorporate both traditional fundamental analysis and sustainability-related externalities in our assessments, which we view as the definition of ESG integration.

Sin # 7: The wrong resume

In our experience, genuine thematic experience is scarce. We believe it is crucial that investment teams on thematic strategies have had specific training and experience in analysing many structural changes, not just time in the market. Covering a specific geography or industry, even for decades, might not produce enough learning opportunities. We advocate instead for a global, cross-sector approach. An independent relationship with highly experienced research analysts can provide a valuable reality check.

Access the full version of The Seven Sins of Thematic Investing here

The Lazard Global Thematic Equity team manages the Zurich Investments Global Thematic Focus Fund and Zurich Investments Global Thematic Share Fund. You can find out more via Zurich's website.