September 07, 2021
September 07, 2021 | Adviser News
The Seven Sins of Thematic Investing: Sin No. 1 Narrative Fallacies
by Lazard Asset Management
Thematic strategies are particularly vulnerable to building themes around slick, but ultimately 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, in which investment teams seek out evidence that confirms a strategy’s relevance and ignore evidence that undermines it. These risks can be mitigated by introducing competition for capital across multiple themes.
Lazard Global Thematic Approach
|Narrative fallacies||Simple, appealing stories which ultimately do not translate into investment returns||Themes must represent a genuine underlying investment opportunity.|
|Single-theme strategies||Outsources the key decision of theme selection; greater risk of confirmation bias and agency problems in assessment and disclosure of theme merits, risks, and expiry conditions.||Multi-theme approach establishes competition for capital between themes; theme selection insourced and acknowledged as portfolio manager’s responsibility and source of added value.|
Long-term investors are highly susceptible to what we call the narrative fallacy - an appealing story that fails to translate into long-term investment returns. We believe a theme should represent not just a broad idea but a potentially positive long-term investment opportunity. The world of thematic investing is unfortunately rife with products that capture the imagination but on further scrutiny do not confer a genuine benefit in terms of return, risk, or sustainability objectives. This commercial window dressing does a disservice to more robust thematic strategies, which may find themselves dismissed without due consideration.
The narrative fallacy problem poses a particularly potent risk when a single theme is the entire investment proposition. Single-theme strategies should come with a crucial acknowledgment: They outsource to the client one of the most critical investment questions - is this theme a good investment?
To be clear, single-theme strategies can be robust investments, and some clients and asset owners will have the knowledge and expertise to select winning themes. Yet, single-theme strategies compound agency risks around confirmation bias, in which the portfolio manager seeks corroborating evidence to support the thematic thesis and discards evidence that undermines it. The alternative - retiring the theme and hence closing the strategy - is typically an unpalatable option.
In contrast, a key benefit of multi-theme portfolios is that they ensure competition for capital across themes. When the retirement of a theme is not an existential crisis for a money manager, but rather an allocation decision, it can be approached dispassionately. There is every incentive to identify the themes that are truly compelling at any given time and no penalty for an honest assessment that a theme has run its course.