Thematic funds can be part of your core portfolio if you can bear the deviation from broader indices

Vafa Ahmadi, CIIA, Managing Director & Head of Global Thematic Equities, Amundi

Thematic funds are on the rise globally and Paris-headquartered Amundi, the world’s fifth-largest asset manager, is one of the leaders in this segment. So much so that CPRAM, one of its subsidiaries, largely focuses on thematic investing. As of December 2023, CPRAM managed assets worth 57 billion Euros (roughly Rs 5.15 trillion), of which 31 percent is managed in thematic funds. Heading its thematic funds is Vafa Ahmadi, who at the beginning of April took over as Managing Director & Head of Global Thematic Equities at Amundi and will now supervise the whole thematic range.

Amundi holds a 36.73 percent stake in SBI Funds Management, India’s largest mutual fund house. State Bank of India holds the rest.
Managing thematic funds is as rigorous as it is exciting, Ahmadi told Moneycontrol’s Kayezad E. Adajania during an interview in Mumbai last week. It requires an AMC to deploy sector or thematic experts to research, sometimes for months, and back-test rigorously before deciding to launch such a fund.

Edited excerpts:

Why is there such a boom in thematic investing globally?

Retail investors, including high networth individuals and family offices, understand and identify with the themes and trends that thematic funds track. For instance, ageing is a theme most of us relate to. This is a massive trend in not only in Japan, but also in some parts of Asia, including China. We all age, whether you like it or not. The question is: how we can make a performance out of it.

Similarly, digitalisation of our world is a fact.

Investing in trends has become a major tool that helps us interface with our investors. Retail, as I said, has taken to thematic investing, but now even institutions are showing interest. Institutions were reluctant to invest in themes because they read markets in terms of sectors and geography while thematic gives a transversal way of looking at everything. That’s changing.

Second: the way people read markets globally is changing. For instance, if you are tracking pharmaceuticals, you don’t care if the company is Indian or American. The thrust now is to understand the underlying trend, the theme, that drives a company.

We see a lot of family offices, which cater to large rich families, and mid-sized institutions that go to fund managers like Amundi with mandates (Request for Proposal) to launch, say, climate funds. Is climate a theme? Yes, but it's more of a transversal risk, as well, that we have to address. But at its most basic, it is a theme.

Amundi also has a Climate Fund called CPR Invest – Climate Action Fund. But on a past 3-year and 5-year basis, it has underperformed its benchmark index. Why?

It's very close to the benchmark. Yes, it has slightly underperformed. In 2023, markets moved up narrowly. The Magnificent Seven stocks (Nvidia, Meta, Amazon, Microsoft, Alphabet, Apple and Tesla) went up by at least 49 percent in 2023. Almost every other segment of the market underperformed. Very few actively-managed funds outperformed that were not invested in the Magnificent 7.

There is a lot of interest in climate change. Explain to us how you identify companies that fit this theme. Would it be much broader than, say your other fund that focuses on hydrogen (CPR Invest – Hydrogen), which was launched in December 2021?

There are sub-plots like ‘circular economy’, ‘blue ocean biodiversity’ and so on. When it comes to climate, there are two main ways of dealing with it. One: To invest in solution companies or enablers. Two: to look at transition.

Both these approaches have different risk profiles and therefore, different performance patterns. First: what is a solution fund in climate control? It’s about investing in those companies that provide a solution to combat climate change. Take the case of a wind farm, solar panel; we will invest in such companies because they bring a solution.

Next, when it comes to transition, it’s about investing in companies that have pledged to decarbonate their trajectories. And decarbonation of the economy is only possible if every sector of the economy decarbonates. Say a major US bank or a pharmaceutical company that has pledged to decarbonize or lower its carbon footprint. As long as they have sound financials and they have taken the pledge that they would decarbonize every year by a certain percentage, they become eligible for our climate fund. And in this fund, we invest globally.

Do you monitor the transition of companies that have taken the pledge? Also, their risk-return would be higher, right? Since you’ve got to see the results of such a transition every year to see if they are on the path...

Oh yes, we monitor. Every month, every year.

Remember, investing in transitioning companies has a higher risk-return profile because these companies have made a pledge to lower their carbon footprint. Their Key Performance Indicator, which is how much their Carbon Dioxide output has gone down by, needs to be monitored. This should, as I said, come down progressively and continuously, by 2030, 2040 and so on, because they have made a pledge.

How do you separate a theme that might be good for the short-term from those that would do well over the long-term? How do you differentiate?

We spend a lot of time doing this. It's fundamental for us to understand if what we are proposing to the market is a long-lasting theme or just a buzz in the market. And for doing this, we actually submit our thoughts to our macro/strategy team, which digs further. It takes them some time. This is not an overnight process. They dig into it, try to gather pieces of evidence. Will this theme grow? How would the growth pattern be? Is there private investment or just public spending or both? What would the size of this theme be; the companies that fit in the investable universe for the next five to 10 years? Are we at the beginning of this theme’s lifecycle, in the middle of it or worse, at the end already? Imagine launching a fund based on smartphones in 2007, when the iPhone entered the market. Today, there's no growth. Everybody's equipped with a smartphone.

Have you come across, researched trends only to find out that they were fads?

Yes. For example, we studied the theme of ‘Scarcity of Resources (natural resources)’. That's a very good topic. We did many, many back-tests. This theme did not give alpha for a single calendar year. We decided to drop the idea.

How far back did you study this theme before you dropped the idea?

Ten years. By putting our themes to rigorous testing before we launch a fund on it, we ensure that we are onboarding something that is meaningful, long lasting and that we have enough stocks in order to justify active management, making sure that the stocks have liquidity and the coverage of the investment universe is respectable.

What are the next 2-3 big themes that CPRAM – Amundi is looking at?

I cannot talk about that.

But you can imagine the technology part and what's going on and Artificial Intelligence (AI) will be part of it. Since Amundi is one of the world’s largest providers for actively managed thematic funds, we have a very large product range. That’s why it is important for us to make sure that any new scheme we launch, it must make sense for our investors.

You also look at megatrends in search of themes. This  is something that is slowly coming to India in the way fund managers identify tomorrow’s multibaggers today. Do all megatrends convert into themes?

According to the United Nations, there are five megatrends. But we look at three major trends: Demography, Planet (climate, biodiversity, etc.) and Technology.

Not all megatrends turn into themes for us. For instance, we got a Request For Proposal to launch a fund on Space. We did a lot of research on that and realised there aren’t enough companies. If we have to manage a portfolio of 40 to 60 stocks, we have to have at least 150-180 stocks in the investable universe for us to pick and choose from. That wasn’t the case and we also need specialised expertise to do research on themes. Therefore, we dropped the idea; I just didn’t know how to do it. Not everything is viable for me.

There were also a lot of thematic funds globally, because there was hot money chasing new and so-called promising themes. And while there are many thematic funds with many ideas, not all of them are very solidly conceived. And when markets go down consistently, both inflows and performance suffer. This also clears all the over-capacities and some excesses from the market.

Plus, we had high interest rates in the US for some time. So investors withdrew from thematic funds and switched to safer havens. Hopefully when inflation goes down and interest rates, inflows will be back in thematic funds.

Remember: Thematic investing is a resource-heavy business. You cannot sit in an air-conditioned office and make judgements about how global themes move. Fund houses must have the expertise. Also, a thematic fund is a multi-sector fund. When you talk about aging, it's not only about health care. It's about elderly leisure. It's about asset gathering. It's about nursing institutions, is about security, and much more. Fund houses must bring multi-sector expertise. Therefore, you need to have a large team of analysts, reshuffling and generating ideas.

Do you ever face an issue where there just aren’t enough ideas and you have to shut the fund to further inflows?

Each fund is tested for capacity at its conception, under normal market circumstances and in stressed market circumstances. We have thresholds under which we will not invest in, say very small-size companies or those stocks with low liquidity in order to assure a level of liquidity. We also see how big a fund can grow, without changing its strategy. We like to have a buffer in size, else there's no use of launching a fund and then closing it.

Where do thematic funds fit into an investor's portfolio? Are they Core or Satellite funds?

That depends on how much risk an investor can take; how much deviation from the larger equity index you can bear. If you can allow yourself to deviate from an index for some time then it can be a part of your Core portfolio. Else, thematic funds can be your Satellite funds.

Which are your most successful and least successful thematic funds?

Our Global Disruptive Opportunities theme has been one of the most successful; also, it is one of our largest thematic funds. Netflix killed the video-renting business. Uber didn't kill taxis, but brought a new market into existence. Disruption is about innovation of rupture. We launched this fund in 2016 saying that disruption doesn't necessarily happen only in the Technology sector. Technology is a big part of it. But in pharmaceuticals, the way we deal with cancer has changed. The way we deal with the planet is changing, and so on. In industry, many things are changing.

What is the least successful theme you’ve had?

The Circular economy theme. It's a model of linear consumption; take, make, use. You take from the earth and you make, you use and you throw. This theme focused on recycling. We're talking about renewable energy, for instance. It's about responsible consumption, about brands that are using more and more recycled material in their production process, et cetera, et cetera.

But this fund has just been around for a year and has just weathered the storm of the Magnificent 7 in 2023. So, let’s give it some time.

How do you study government policies, which can have a lot of ramifications on how these megatrends and trends play out?

We try to assess that. Well, it's part of our understanding of a theme. Hydrogen, for example, which is a theme, a strategy we've launched two-and-a-half years ago has huge interactions with what we call PPP, public private partnerships. How, for example, the European Commission has been active in developing a hydrogen ecosystem, for example. Or how regulation in the US of the healthcare system will or will not impact the prices of drugs and how the pharmaceutical companies we invest in will behave. So, it's part of the understanding of every single fund.