Olly Smith: Well, it’s theme week at Morningstar.co.uk. So the right person to join Morningstar’s studio is Kenneth Lamont, a senior analyst in passive strategies who speaks on topical themed questions. Kenneth, thanks for joining us. First of all, what worked and what didn’t about the theme? What’s hot? What is not?
kuala lumpur: Before getting into specifics, I think it’s worth framing the question as there are some general characteristics that almost all passive funds have. One is that they tend to have a growth bias. That makes sense. We’re trying to capture some kind of future growth. Therefore, these funds tend to do well as a cohort. These seem to be tied to the fortunes of growth stocks in general, and have performed particularly well during times such as the post-COVID-19 recovery. It really knocked it out of the park. I mean, it’s a big number. But similarly, subsequent calculations of that kind of technology suffered some of the worst gains during a barren few years for the subject. With that in mind, it won’t surprise any of our viewers if the most successful and highest-grossing themes of 2023 are AI and big data. It can be said that this was the year when AI became popular in a good way. This shouldn’t surprise anyone, but it’s interesting. One of the great things about themes is that you can actually see trends unfold before your eyes in real time. So AI is the big winner this year. Some may be surprised by the big losers. That was battery technology. This was the kind of thing where battery stocks really, really suffered due to reduced demand from China and an oversupply of some of the key raw materials for battery technology, such as lithium.
OS: Understood. And from a risk perspective, because I think on the one hand it’s an optimistic case for some really exciting trends that are going on in real time, as you say. Our understanding of risk is also evolving in real time. So what do investors need to know now about the risks of investing in themes?
kuala lumpur: First of all, many, if not all, thematic funds are risky by design. These are designed to target very specific risk and return factors. And that means it’s often very volatile because it’s a very concentrated basket of stocks. And every investor investing in a theme needs to really understand it before investing. For example, I mentioned earlier that battery technology suffered tremendously last year, but in 2020 it was the best-performing theme we tracked, with a return of almost 90% for the year. More than 90% of is the theme average we calculated. Obviously, these are highly volatile, but there is an element of risk, not just historical volatility, but especially when it comes to themes, and you have to consider that many times. We talked about AI, and actually one of the biggest risks to the growth of AI is regulation. This has never happened before. It’s very difficult to actually set an inaccurate price, and no one really knows, but this is some kind of bus coming through the tunnel in the opposite direction, and what happens to it? I don’t know. So looking back doesn’t tell us much about how it will impact AI’s future profitability.
OS: Therefore, there is some uncertainty. Right off the bat, and finally, I mean, do you think this is still an optimistic game? I mean, I think a lot of people will invest in the theme because they’re excited about the future, especially the solutions to the world’s big problems. However, there are several reasons to be cautious. After all, are you still an optimist on the subject, or are you a little more cautious than before?
kuala lumpur: No, actually, I think the last few years have actually proven that it’s a legitimate lens through which to look at investing, despite the poor performance of the theme. If you look at what has fueled global markets over the past 18 months, it’s not geography, it’s not sector, it’s not AI; it’s the theme. And one of the really positive things I’d like to make is that we’re seeing a clear growth in society and enthusiasm for this theme, and that’s reflected in the performance of funds that actually claim to be tracking that theme. It’s about being there. It supports the purpose of the theme. So I actually think the last few years have been very positive for thematic investing through funds, despite the poor performance.
OS: Certainly, there may be some degree of transparency. Thank you so much Kenneth. Check Morningstar.co.uk throughout this week for more information on the theme. There, content on thematic investing will be published in collaboration with other European websites. Until next time, thanks again Kenneth. I’m Ollie Smith from Morningstar.
