The Trouble with Thematic Investing
Now, and then you might hear about all kinds of themes out there. Baby boomers are retiring – how to invest. Automation and robotics – how to invest. Climate change – how to invest. Each time we learn about some newly discovered theme, it seems compelling to chase it and ride the wave of alleged investment opportunities that may follow. Is it really a good investment policy, though?
At times, the question of thematic investing comes up in our conversations with clients. After the portfolio review and the discussion of some new investment ideas, they might be curious about work from home as a theme, for example, and want to know if we invest in it and how.
A few months ago, a big player in thematic investing closed its doors after ten years. They are not the only ones in that space, but they caught my attention a while ago. With serious backing from major financial firms, they wanted to offer investors an opportunity to create their own themes or used predefined themes to build investment portfolios. You could put 30% of your capital in baby boomers retiring, 30% in automation, 30% in climate change, and to spice it up 10% in our vices, for example. One of the more intriguing themes they followed was investing in brands with the most likes on social media.
I watched their approach carefully. I’m always curious about new ideas, new strategies, and theme investing is a theme (or a fad?) in itself. It tends to come back in various shapes and forms now and then. Speaking of vices earlier, I thought what this company offered satisfied the temptation among investors to discover or capture new and old themes out there. Apparently, despite massive financial backing, marketing exposure, and hundreds of millions raised in venture capital funding, it still failed to attract enough theme seekers.
They are not the only ones. I recently read about a theme that’s a mouthful to say: it’s a renewable energy theme that captures the decarbonization opportunity of cryptocurrencies—lots of big words. Cryptocurrencies have been a theme for a while on their own, but the tide seems to be turning for now. Even Elon Musk himself recently experienced a sudden change of heart when it comes to cryptocurrencies. He apparently only now discovered how much energy is consumed by Bitcoin and lost interest in it with a single tweet. By the way, that’s how suddenly most themes (or rather fads) start and end historically. It’s never obvious whether a particular theme is a truly long-lasting tailwind to a certain industry or just a fad that will go away with a single tweet.
Elon Musk wrote on May 12, 2021: “Tesla has suspended vehicle purchases using Bitcoin. We are concerned about rapidly increasing usage of fossil fuels for Bitcoin mining and transaction, especially coal, which has the worst emissions of any fuel.” While, only two months earlier, Tesla started to accept Bitcoin as payment.
Interestingly enough, Bitcoin lost about 50% of its value in dollar terms between those two tweets. If Tesla were to honor its Bitcoin price from March in May, it’d be getting only half the amount in US dollars.
Bitcoin volatility aside, Tesla’s brief infatuation with Bitcoin made me wonder: can themes cancel each other out? If you buy a Tesla with hopes to promote renewable energy but pay with Bitcoin and contribute to its carbon footprint, what’s the outcome? Mostly positive or mostly negative?
Forbes explained in a May article: “it’s Bitcoin’s decentralized structure that drives its huge carbon emissions footprint,” and what’s more, Bitcoin transaction take upwards of 10 minutes, while “other digital transactions, like those powered by Visa, take less than a second and use roughly 1/500,000 the energy because they rely on a centralized authority to verify transactions.”
If that’s the case, isn’t investing in renewable energy in the name of decarbonization of cryptocurrency an attempt to solve a problem that we don’t need to have? The very problem that was supposed to be actually a solution to other aches could be in itself so much worse than what we are already using today.
At least, that appears to be the case today.
Thematic investing has its challenges. Themes can apparently be built on top of other themes just like the one mentioned above. What gets totally lost in the conversation is the underlying business. Does it even make sense? Does it provide a needed service that others are willing to pay for? Can it generate profitable sales in the process?
This brings me to an explanation of how we invest. Theme or no theme, we look for a business that has good fundamentals. It grows its sales, and currently or in the foreseeable future can earn respectable profits. We want to understand its market potential and competitive advantage. Once we have that established, we think of the right price to pay for it. Even the greatest opportunity may prove to be a disappointing investment if we pay too high of a price.
In other words, what we do is start with the fundamentals of the business. Then we can see if there are any tailwinds worth considering. If we find out that our potential investment target may benefit from baby boomers retiring and increased interest in renewable energy, that’s a bonus. We don’t let the tailwinds alone tell us where to go, though. It could take us deep into some unfriendly financial mangroves, and we wouldn’t want that.
The challenge with thematic investing is that investors’ interest fades quicker than many expect; what’s more, few pay any attention to the fundamentals behind the businesses, and it’s the fundamentals that always prevail. When we find a good, growing, profitable business bought at the right price, it’s likely to turn out to be a good investment. A theme may play a role, but it’s more of a bonus than a reason in itself.
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