Christine Senior explores the drivers behind the recent explosion in themed fund launches and asks how pension funds should approach this new trend
But why this surge of new products now? Could it be that mainstream managers have been missing a trick, while specialists have been quicker off the mark?
"Many mainstream managers have been slow to pick up opportunities like clean water, clean energy," said Tim Currell, senior investment consultant at Hewitt Associates. "I think that's why these themed funds have started to spring up because there are opportunities there that are not being captured by mainstream managers."
While many new funds have come on stream in the last couple of years, some managers were early to realise the potential for growth here.
Pictet has a track record in themed funds, with a biotech fund launched in 1995 followed by water, generic pharmaceuticals, premium brands, security, clean energy, digital communications and most recently a timber fund. These are themes that, though they have come to the fore quite recently, look set to dominate for some time to come.
"Climate change, the environment, demographics and ageing of populations -- these are real mega trends that you can capitalise on via some rightly profiled investment funds," stated Laurent Ramsey, group managing director and CEO of Pictet Funds. "Rising healthcare costs and water shortages are real, and happening in front of our eyes. If you have investment funds that look at these mega trends, it is bound not to be a fad. What you have to look at is funds that try to gain pure exposure to these themes, this is what will make the difference between a good and a less good product."
The stage is set for companies that are actively pursuing environmental themes to benefit from the prevailing focus on cleaning up the planet. Regulation on a regional or global scale is getting tighter. The EU has a target of 20% of energy to come from renewables by 2020, and Asian nations are tackling their own environmental problems arising out of rapid economic growth.
"For the first time China has put the environment on top of the political agenda in the China five-year plan," explained Rositsa Shivacheva, SRI investment specialist at Fortis Investments. "They have a target they want to meet. That is creating a very exciting area for companies to be in. In the last five years we have seen a lot of companies expanding their activities to Asia to help solve problems."
Jumping on a bandwagon?
But not all managers will be equally well equipped to manage themed funds. Ramsey said successful managers needed specific skills to identify companies that provide value in the less researched areas of the market.
"Usually these funds, if they have purity, focus on less researched companies that are not covered by all brokers. These are small or mid cap stocks. The funds invest in less efficient markets so there is more potential to extract value from them."
His views were reflected by Christian Werner, CIO of SAM Group, which is specifically geared to running specialist themed funds. The company runs funds on the themes of sustainable water, smart energy, smart materials, sustainable healthy living and sustainable climate. Werner believed a number of mainstream asset managers had jumped on a bandwagon of sustainability themes without necessarily having the scientific expertise to back up the research.
"A lot of managers manage straightforward European or global funds, and take on a themed fund in addition, but they don't have support from strong research," he said. "We support our sustainability themed funds with almost 20 analysts, and that means people who come from the industry. For example, on the water side we have people who were installing this equipment in the Middle East, so they really know what they are doing."
In research conducted around six months ago, Mercer identified around 1,000 funds with clean tech or climate change themes. Only around a dozen of those had been around for five or ten years, the rest had launched over the last two years.
"When we went through screening them we found a lot that weren't run with very good expertise or resources," commented Danyelle Guyatt, a principal in Mercer's responsible investment team. "There is a risk of a bandwagon. but there are some very good investment opportunities, and good fund managers managing those. It's a question of sifting through the rubbish to find good managers. We have developed a robust research process to cut through bandwagon managers versus those we think will last the distance and have skills."
Pension funds and themed funds
Themed funds have been popular among private investors, but with pension funds they face obstacles in getting acceptance. A major one is that they do not they fit easily into a pension fund's standard asset allocation. Funds are not all of a kind -- some invest in listed equities, some are private equity funds and some follow the theme across different types of asset classes. This makes it harder to place them in a portfolio.
"One of the main obstacles to overcome for institutional investors is they normally have quite a straightforward asset allocation model, limited in a way so it cannot deal with this kind of new theme," said Werner. "In which bucket would you put a water fund? They have to see the opportunity that is in there and try to fit that to their model. A lot of them allocate a water fund to the alternative space. They get rid of an asset allocation model that just looks at Europe, the US and Asia, and large, small or mid caps."
Investing in themed funds can also run up against the barrier of governance resources, which may place them out of reach of all but the largest pension funds. For diversification, investors need a range of funds.
"We would encourage schemes to set aside, say, 5%, but only the biggest funds are able to go into these themed funds," said Currell. "They are very niche. You would need to have a 5% allocation and build up a small diversified portfolio so you are not just concentrating on one theme. If you are thinking about adding four or five relationships for a small slice of fund it's only really big schemes that have the governance. It's a question of governance, not assets under management.
"You have to research available funds, you have make sure you are confident about the manager, and you have to look at how they fit with your other investments. Often they are multi-asset, not just equities but commodities, property, and they don't necessarily have a long track record."
At Mercer the advice to pension funds contemplating these kinds of investments is to first look at what their existing fund managers are doing in this space to see if they are taking advantage of climate change opportunities. Then the consultant recommends private equity funds as a way to access the theme.
"We think it makes more sense as a private equity allocation because you are capturing more the venture cap end of bringing to market new technology, whereas with listed equity hopefully your mainstream equity managers will be taking climate change into account," said Guyatt. "For themed funds it really depends on the asset allocation of the pension fund, their risk exposure, the need for liquidity and all those issues."
But from a wider point of view, climate change, alongside other sustainable investment themes is potentially attractive as an investment for pension funds, partly because it is an issue that will be important for the long term.
Simon Webber, fund manager of Schroder's Climate Change Fund, which was launched last September, explained much of the early interest in these funds came from retail investors, but this is changing. "Increasingly we see institutions consider the trend," he said. "When you think about it, it is a more natural fit when you have long dated liabilities. It's a theme that will be important in a timeframe that lots of institutions care about."
It's still early days to judge long term performance, but evidence so far points to the funds posting strong returns, compared to mainstream indices. The FTSE ET50 showed annualised returns of 26.4% over three years, and 24.3% over five years to end August, compared with 4.02% and 8.24% over the same periods from the MSCI World. Werner says the SAM Water fund has outperformed the equity market almost every year since inception, while Pictet's Biotech fund has posted cumulative returns of 38% over three years and 73% over five years.
The appetite for themed funds is certainly evident among institutional investors, and looks likely to grow in future. The UK's Environment Agency Pension Fund has recently invested £24m into Robeco's clean tech private equity fund. SAM has just won mandates from two large US institutions to run segregated mandates on a theme of water. These are not the first - and most certainly will not be the last - to latch onto the opportunities offered by themed funds.
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