Critics often see thematic investing as a marketing gimmick – an investment strategy used by certain asset managers to merely piggy-back on the latest investment trend. To others, however, it is an effective strategy that frees a portfolio manager from the narrow geographic or sector views imposed by other approaches, and gives the manager the flexibility to invest wherever they see an opportunity in the global economy. Oliver Kratz, head of global thematic equities Deutsche Asset Management (DeAM) is one of them. For him “thematic investing is as important an approach as growth investing, value investing, contrarian investing, and the like,” he says. “And we use this research-driven, top-down/bottom-up strategy as a key building block of our investment platform.”
Clearly, if an area of outperformance can be identified and invested in it before others, it will generate significant alpha. Thematic research is said to uncover such opportunities at an early stage. Mr Kratz gives an example: “Two years ago we identified an investment opportunity in biofuels. Back then, everybody would shake their heads in disbelief at us as there was little external interest in this investment area. “Now,” Mr Kratz explains, “the main value of his thematic research into biofuels was not that it enabled him to market timely funds, but that it helped him to make timely investments on behalf of his clients.”
Few themes are constrained to one industry or geographical region, which is why traditional research will often uncover only part of a major trend. By identifying and understanding relationships across sectors and regions, thematic research can expose alpha-enhancing ideas. The challenge for investors is to define the limits of a theme. For example, some managers could limit investing in infrastructure to utilities such as water, gas and power, along with physical networks such as transport networks. Others could use a wider definition that includes financial networks such as stock exchanges or IT networks that take into account such factors as the explosive growth in broadband driven by video demand. In this case, adopting a wider definition could have proved highly lucrative for investors.
No limited approach
Similarly, a more limited approach can be better under different circumstances. Mr Kratz says: “The key to deciding on which limit to set is a very clear investment process – because there is much more to thematic investing then just gut-feeling.” At DeAM, the investment process starts with in-depth research, collecting data around a qualitative theme definition. From this point, the process becomes quantitative: the inputs and outputs of the theme are investigated, leading to stock valuation. Screens can range from more traditional metrics such as earnings revisions momentum, return on equity and cash flow return on investment, to risk comparison and spreads. Cash flow and return on capital forms of analysis appear particularly suitable for thematic research, as trends often play out over a relatively long time period.
Having identified the preferred securities, portfolio construction and risk management follow. This is exceptionally important as the thematic-based approach means that the expected return of the fund can be non-normal. In short: “1) define the universe, 2) identify the signals, and 3) test them for significance and persistency and clean the screen,” as Mr Kratz puts it. As a result, this boils down a considerable universe of stocks down to the most promising ones to pick. “For example, in our analysis of agri-business, the initial screen identified 1,280 companies”, Mr Kratz explains.
Such a sample set allows for the systematic analysis of risk, whether common factor risks – the universe covers sectors ranging from water utilities and financing companies to chemical and logistic enterprises, as well as both emerging and developed market exposure – or stock-specific risks. “We make no apologies, however, for targeting our investment portfolio on a defined sub-set when rigorous analysis identifies this as a high-return area”, adds the investment expert. The success confirms his strategy.
Deutsche Asset Management
With more than €540bn (as of September 2006) in assets under management, Deutsche Asset Management (DeAM) is one of the world’s leading investment management organisations, not just in size, but in quality and breadth of investment products, performance and client service. Deutsche Asset Management in the Americas, Europe and Asia provides the full range of investment management products across the risk/return spectrum. Our diverse institutional client base includes pension funds, insurance companies, corporations, local government authorities and charities. We are committed to producing consistent, risk-controlled performance for our clients and adding value through all stages of the investment process.
