September 07, 2021

September 07, 2021 | Adviser News

The Seven Sins of Thematic Investing: Sin No. 6 Failure to Integrate

by Lazard Asset Management


We observe that managers tend to make three mistakes when claiming to incorporate sustainability into their investment processes: failing to do it, pretending to do it, or doing it badly. We place equal weight on both traditional and sustainability-related externalities in our analysis, which we believe is the very definition of ESG integration.


Implementation Risk


Lazard Global Thematic Approach

Failure to consider sustainability issues and non-financial externalities Analysis of structural change does not consider shifts in societal norms. Incorporate both financial and non-financial drivers of structural change in an integrated Global Framework.
Greenwashing Marketing emphasizes “green” themes and stocks but these do not translate into return opportunities, risk mitigation, or sustainability objectives. Clear disclosure of strategy objectives with explicit connection to process and portfolio
Policy assumed to be constant or linear Legislation and regulation are held as constants or linear as changes are assumed to be “unanalyzable”. Use policy goals and directives such as climate change policies or the UN Sustainable Development Goals (SDGs) as likely indicators of the direction of future policy change and align themes accordingly.
Assume a permanent societal license to operate Societal acceptance of a company’s behavior today is extrapolated into the long term Continually test for idiosyncratic risks to societal license to operate; remove stocks that fail to meet threshold.

When initially identifying structural change, many thematic strategies fail to incorporate an analysis of non-financial externalities into their view of the future. A broader approach acknowledges that insights may focus on either traditional industry change (e.g., competitive dynamics, industry structure, disruptive technology) or a wider range of ESG and sustainability-related issues including cultural shifts, changes in societal attitudes and norms, and shifts in regulations and policy.

Unfortunately, greenwashing - the largely cosmetic bolstering of a product’s sustainability credentials, primarily for marketing purposes - is widespread in the investment industry. This is as true in the thematic equity space as it is in other areas. The robust alternative to greenwashing is to fully integrate sustainability considerations into all stages of the process - identification of structural change, theme creation, and stock selection - and to think as hard about non-financial change as we do about more traditional areas of financial analysis.

Our Global Framework incorporates a holistic range of inputs, including those which suggest long-term shifts in societal norms. For example, we consider the direction of future policy through ongoing shifts in existing policies on global issues such as climate change. As policy frameworks evolve, our Global Framework can evolve alongside them, helping to ensure our view of the world is not locked to a redundant or obsolete policy model.

The analysis of the likely direction of future policy can yield valuable structural investment insights - we want our themes to be on the right side of future policy change. Specific sustainability goals such as the UN SDGs may be useful indicators of future policy direction. Whether specific themes “target” these goals explicitly or the theme construction process incorporates an analysis of alignment with these potential policy shifts is largely, in our view, semantics - again, we note that specific policy frameworks do change over time and hence can become redundant or obsolete. We can map the positive alignments between our themes and, for example, climate change policies or UN SDG solution pathways to demonstrate where we believe our consideration of sustainability goals provides additional support for our investment views. In all cases, the aim should be to enhance returns by integrating both financial and non-financial structural shifts into theme construction, such that returns may be enhanced.

At the stock level, we would highlight two further considerations that we believe can enhance returns, and mitigate sustainability-related risks.

First, all themes are aligned with what we see as probable policy change. Since we insist that all stocks are chosen specifically to fit a particular theme, all stocks in a portfolio are likely to be on the right side of forthcoming policy changes. Thus, we believe the stocks we invest in are part of the solution to societal goals, rather than part of the problem.

Second, all stocks considered for the portfolio are subject to our Sustainability Framework which integrates multiple aspects of business risk, including formal ESG inputs. This framework focuses on the strength of the relationships companies and industries have with society - the societal license to operate - and how this might change over time. We believe the breakdown of these relationships is the key mechanism through which sustainability risks impacting company fundamentals. The Sustainability Framework consists of a three-step process that assigns companies a series of scores, each incorporating a direction of change, which must pass a minimum threshold level to qualify them as potential investments. Our Sustainability Framework aims to ensure that companies exposed to the risk of a deterioration in societal license are excluded from the portfolio. More details are available in a separate paper1.

Questions to Ask the Manager

  1. How do you incorporate sustainability considerations into your process?
  2. How do you prioritize sustainability considerations compared to financial return and risk objectives?
  3. Do you claim that your strategy has sustainability objectives? If so, how do you measure sustainability?
  4. At the stock level, is there a systematic methodology for determining which stocks are excluded from consideration for themes?

1 A comprehensive description of our Sustainability Framework can be found in our paper, “A Sustainability Framework – Societal Shifts as Investment Risks.”

September 07, 2021

Insights from our Partners: The Seven Sins of Thematic Investing

Lazard Asset Management’s Global Thematic Equity team shares its decades of experience in identifying and avoiding the seven sins of thematic investing.

September 07, 2021

Insights from our Partners: Sin No. 1 Narrative Fallacies

Thematic strategies are particularly vulnerable to building themes around slick, but ultimately empty, marketing narratives rather than genuine return opportunities.

September 07, 2021

Insights from our Partners: Sin No. 2 Foggy Forecasting

Forecasting, particularly as far out as the next decade, is at best imprecise and at worst dangerous. Investors should ask managers where their ideas originate and prioritize sources grounded in real-world experience rather than popular consensus.

September 07, 2021

Insights from our Partners: Sin No. 3 Sledgehammer Scope

Generic investment ideas are sledgehammers - simple, broadly defined investment propositions that make an immediate marketing impact but can leave lasting damage to portfolios. Themes that are designed too broadly in scope may not target the actual return opportunity.

September 07, 2021

Insights from our Partners: Sin No. 4 Puzzling Purity

Stocks that appear to be valid candidates for a theme might actually have very little relevance.

September 07, 2021

Insights from our Partners: Sin No. 5 One-Trick Pony

Having multiple themes is of no benefit if they are all the same underneath the surface.

September 07, 2021

Insights from our Partners: Sin No. 7 The Wrong Resume

Genuine thematic experience is scarce. We believe it is crucial that investment teams on thematic strategies have had specific training and experience in analyzing many structural changes, not just time in the market.


Important information: The content of this publication are the opinions of the writer and is intended as general information only which does not take into account the personal investment objectives, financial situation or needs of any person. It is dated August 2021, is given in good faith and is derived from sources believed to be accurate as at this date, which may be subject to change. It should not be considered to be a comprehensive statement on any matter and should not be relied on as such.  Past performance is not a reliable indicator of future performance and should be used as a general guide only. Neither Zurich Australia Limited ABN 92 000 010 195 AFSL 232510, nor Zurich Investment Management Limited ABN 56 063 278 400 AFSL 232511 of 118 Mount Street North Sydney NSW 2060, nor any of its related entities, employees or directors (Zurich) give any warranty of reliability or accuracy nor accept any responsibility arising in any way including by reason of negligence for errors and omissions. Zurich recommends investors seek advice from appropriately qualified financial advisers. Zurich and its related entities receive remuneration such as fees, charges and premiums for the financial products which they issue. Details of these payments can be found in the relevant fund Product Disclosure Statement. No part of this document may be reproduced without prior written permission from Zurich.

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