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An Analysis of Thematic Portfolios Construction, Risk and Returns

Jul. 25, 2019

Jul. 25, 2019

 

Thematic investing has been one of the most talked-about topics in the asset management industry over recent years, led largely by innovation in index-based products.

In an earlier article, we covered the strong growth in thematic investing, and the characteristics and rationale of portfolios pursuing themes-based strategies. STOXX’s Thematic Indices family now includes over 20 indices targeting strong concepts disrupting our digital world

A new research paper by Anand Venkataraman, Head of Product Management at STOXX, describes in detail the megatrends and themes that come together to propel the concepts behind each index. Of special interest is his analysis on each index’s risk and returns profile, including factor-based performance attribution — a route guide that can help understand the drivers of performance and uncover any unintended systematic biases in the thematic strategies.     

Thematic megatrends are “powerful macroeconomic transformative forces that have a major impact on countries, businesses and societies around the world, disrupting the way products and services are created, delivered and consumed,” Venkataraman writes in the study. “Capitalizing on such a megatrend involves identifying a potential long-term structural theme and adopting that theme for investing with conviction.”

Confluence of megatrend forces

STOXX has qualitatively assessed the various prevailing trends, collated client feedback and compiled three megatrend pillars — demographics, technology and climate change — to come up with sub-themes for each one of them. The intersection of sub-themes and trends within them is where strong, investable themes or concepts may arise. 

Using two methodologies, one employing revenue-based criteria and another one that resorts to artificial intelligence (AI), STOXX then identifies those companies with the highest business exposure to each concept. 

Performance and factor attribution analysis

A secular trend that was observed with all thematic indices was a positive active return since inception, Venkataraman writes. The outperformance ranged from an annualized 1.4 percentage points above benchmark for the iSTOXX® FactSet Automation & Robotics Index, to 15.3 points in the case of the STOXX® Global Sharing Economy Index. In all of instances, the volatility of thematic indices also increased relative to that of the benchmark. 

To take one example of the granular performance analysis in the study, the STOXX Global Sharing Economy Index’s annualized active return was driven equally by the specific return (8.96 points) and by factor contribution (6.98 points), the study finds.1

Within the factor contribution, industry exposure represents a large proportion of the positive returns (5.42 points), driven by overweight positions in the internet & catalog retail, internet software & services, and information-technology services sectors. The index also has a positive tilt to growth (0.61 points of the total factor contribution) and a negative tilt to value factors (-0.96 points). Momentum also contributed significantly to returns, offsetting some of the other negative style component returns.

A similar analysis is carried out on 19 other thematic indices. 

Overall, strong biases towards specific industries contributed to positive active returns. This is quite intuitive given that most of the thematic indices tackle specific sectors in order to benefit from the megatrend in question. In many instances, the so-called specific return contributed positively to the overall returns, hence indicating a relatively favorable stock selection. 

A bias towards growth was observed in most of the thematic indices, which could be expected since thematic indices attempt to obtain exposure to megatrends as they are evolving. 

Particular risk and return characteristics as key elements

Using systematic index-based approaches, investors may obtain exposure to megatrends that are shaping or expected to shape the future. Investors should consider the appropriate theme for their investment not only based on their assessment of structural change in our world, but also on the incremental active returns generated for each additional unit of risk, as well as suitability and overall impact on portfolios. 

Considering these variables will facilitate an efficient investment in the potential of disruptive themes. 

 

Featured indices

STOXX Thematic Indices

 

While the indices’ overall annualized active return is calculated by using STOXX Indices’ data, factor contribution calculations are obtained from Axioma, which treats corporate actions differently. Hence both set of numbers may not amount to equal figures. 

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