Navigating the Rocky Landscape of Thematic Funds

In recent years, thematic investments and funds have exploded in popularity. As investors look to streamline their portfolios, identify emerging investment opportunities, and align their portfolios with their personal preferences, thematic investing – the strategy of trying to harness various growth themes or ideas – has proved particularly attractive.

Thematic investing has been defined by some as attempting to capitalise on and capture the zeitgeist, from sustainability and artificial intelligence through to healthcare technologies and cannabis. It’s an extraordinary development that Kenneth Lamont has seen first-hand.

“I’ve sat on the fund research desk at Morningstar for more than 10 years”, Lamont notes. “Now a Senior Analyst, I began my career with a specific focus on passive investment funds, mainly ETFs, but over the last few years, I’ve turned my attention to thematic investment funds. In a relatively short space of time, they’ve gone from being a niche, under-researched, and generally ignored part of the market, to demonstrating remarkable growth in terms of size and importance.

As thematic funds have started to make waves in the space, the investment research we do here at Morningstar is essential to providing clarity for investors. This area of research hasn’t really been done previously, so our work is at the forefront of the thematic investing movement, and we ensure that data on these funds are accurate and accessible, and supplemented by a cohesive narrative alongside historical context.”

As an area that’s seen rapid growth, researchers have had to swiftly get to grips with thematic funds and devise new ways to screen and assess them. For Lamont, there’s only one place to start.

“The research reports I publish are focused on proving context on these funds, so as a researcher, my first port of call is almost always Morningstar Direct. The starting point is to screen a fund universe, so within Direct, we can go in and dive deeper into a specific thematic investment fund.

From here, we’re then able to build out the data, so creating a peer group that contains both active and passive funds globally. By creating these datasets and peer groups, we’re able to establish points of reference that can be used to compare funds, which is an essential part of the fund screening and selection process. With this solid foundation of data and research, investors can start to build out their own investment analysis.

We then pull in a huge amount of other data points available within Direct, for example, data relating to environmental, social, and governance (ESG) funds, which helps establish additional screening criteria, especially in areas that investors are increasingly interested in.”

While thematic funds may be in vogue, they’re not without their challenges, which is where Lamont comes in.

“Increasingly investors need more and more resources. It’s not enough to just hand them the data and expect them to become experts in thematic investing. That’s why digging deeper into the narratives which underpin these funds is something we take incredible seriously in our investment research.

However, establishing that narrative requires a significant amount of work and effort, primarily because each fund is defined and tracked differently. When nominally similar funds can result in starkly different investment outcomes, you need to factor in additional time and steps in the workflow to define peer groups and build out the datasets to facilitate meaningful comparisons, bringing in that much-needed context.”

For Lamont, overcoming the challenges posed by thematic investment funds has been paramount to providing investors with the ability to navigate the space.

“Morningstar Direct is at the core of what we do, and its capabilities have been invaluable in enabling us to flesh out the data and define and track all the different fund types.

We’ve built specific targeted thematic tools within the interactive research section of Morningstar Direct, which we use almost daily. Using these interactive notebooks, we’re able to explore a theme in isolation, understand its characteristics and performance and how it might sit within an existing portfolio before moving on to fund selection. This gives us the ability to identify funds tracking a given theme, highlight the key differences, and decide which would be most the most suitable investment.

For investors, this helps them address their most pressing questions about thematic funds. Questions like which thematic investment fund is better? Which one gives me a higher purity? Which fund is better than another?

With this ability to screen funds in greater depth, investors can move closer to that final decision about which thematic fund is right for their portfolio.

Thematic funds are unique in that they embody a complicated mixture of being both potentially empowering and debilitating for an investor’s portfolio. For Lamont, this duality is what makes them so fascinating as an area of investment research.

“The impact of our thematic fund research here at Morningstar has been phenomenal. With the sharp rise in demand for this type of fund, we’ve seen more thematic funds find their way into investors' portfolios. However, in-built narratives can distract from the risks of investing thematically and encourage investors to buy and sell at sub-optimal times, which has led to some unfortunate outcomes.

These funds can be very attractive to investors. In many cases they’ve been launched towards the top of a growth cycle and sold very aggressively to the least sophisticated or experienced investor. Due to their nature, they can be highly volatile, which can exacerbate poor decision-making.

That’s what guides our research. The desire to inform and empower investors from a diverse range of backgrounds and help mitigate some of those potential risks. Our proprietary thematic research, tools, and datasets can be used in conjunction with the vast datasets available elsewhere on the Morningstar platform to build a complete picture of a fund within its broader context and isolate and select the most appropriate investment.

Our world-leading investment research can help investors increase their chances of picking the right investment tracking the right theme at the right time. This all ties back to Morningstar’s mission, which is to champion the investor and enable them to make empowered and informed investment decisions.”

Talk to a specialist about growing your business with Morningstar Data and Analytics.

Kenneth Lamont has not received any cash or non-cash compensation from Morningstar in exchange for this story.