I am delighted to be working with Lawrence Lever and his team over at CityWire in a series of fortnightly pieces on Thematic Investing under the moniker of Market Thinker (a bit of nominative determinism there). The following is by way of an introduction piece and the idea is to discuss Thematic investing in a number of fortnightly articles. Lawrence and the Team have kindly agreed for me to include the full text here on the blog with a lag of a week.
The CitiWire link to the piece was posted last week, but is here.
They even have my new nominative determinism logo…
Metaphors are often a useful way to convey a message and for those looking to better understand the savings and investment industry, its evolution as well as its prospects, they could do worse than consider the parallels with that other giant, slow-moving consumer goods industry – autos.
Bond markets are thus the diesel engine HGVs of savings, the workhorses of investment, they do much of the heavy lifting in the background but their contribution, while invaluable, is hardly glamorous.
There are basically no stories around bonds, no TV shows with tips about the exciting new bond offerings or magazines with profiles of superstar bond investors (except perhaps in the equivalent of the trade press).
Let’s face it, they are pretty dull.
The reason for this of course is that bonds are basically a B2B business like trucking and, as they like to say, bonds are bought, but equities have to be sold.
Equities, by contrast, have always been much more retail focused, full of stories and dreams – far more glamorous. Especially in the US, where the emergence of mutual funds in the 1950s and 1960s largely coincided with the expansion of the car industry.
To extend the metaphor, we can break cars down into petrol and diesel in the same way that we break equities down into active and passive. The US love of petrol cars mirrors its love of equity investing and, with the same values of independence, freedom and individualism, investing is often as much of an emotional decision as a practical one.
The IFA market in the US is enormous, with millions of Americans actively investing their own savings. While Europe, by contrast, is dominated by intermediaries, such as pension funds and insurance companies for whom price and efficiency are seemingly more important than returns.
For them, passive investment is the answer in the same way that diesel cars are popular with fleet buyers. Corporate buyers account for almost two-thirds of auto sales in Europe with diesel accounting for about 42% of the cars in Europe compared with single digits in the US.
Diesel engines are durable, reliable and cheap to run, which is why they are so popular with the accountants, but the actual driver doesn’t really get much of a say, it’s all done top down, effectively as B2B as the trucking business.
If they are lucky the driver might get to pick from an options list of a black, grey or a silver diesel car, much as a defined contribution company pension fund offers a modest choice of monochromatic index funds to its employees.
The company car and the index tracking company pension are thus both bond-like, with a focus on ease of manufacture, low cost of running and low risk to the provider – even if that means low return to the ultimate consumer.
Both the auto industry and the saving industry in Europe are in this sense caught up not only in the principal-agent problem, where the buying decision is made largely in the interest of the agent rather than the principal.
But, also in another economic phenomenon known as producer capture, where thanks to the concentration of buying power in a few hands, the manufacturers or producers of the products are able to ensure that the products are profitable and beneficial to them rather than the (ultimate) consumer.
To do so the producers engage in heavy lobbying of government and regulators and here we see another parallel emerging, between diesel-gate and ESG.
Diesel manufacturers in Europe emphasised the low Co2 emissions but played down the negative effects of particulates in the same way that fund houses emphasised the cost benefits of index funds while playing down the societal risks of misallocating capital through what is essentially a momentum strategy giving cheap capital to the very biggest companies.
For every dollar that goes into tracking US equities, the top five tech stocks get 20 cents and, until recently, the oil and gas industry got 12 cents.
Political pressure has changed this, and the producer led response in both has been something that suits them, hybrid vehicles and ESG investing, both still very much aimed at the intermediary and neither really addressing the real problem.
Most ESG is simply tracking a different index in the same way most hybrid vehicles are only mildly electric. The consumer, rather than producer, led response however is more interesting, thematic investing is growing in popularity in the same way that pure electric cars are.
Electric vehicles are both more efficient and more effective than the legacy products, as well as being much easier to drive and with far more societal benefits, not least in terms of roadside pollution. Now they are getting cheaper and entering the mainstream such that all the major producers are having to adapt.
Thematic investing is similarly more efficient and more effective for the actual owner of the capital compared to legacy investment products and it too delivers more societal benefits.
With the fastest growing pool of consumers of both products being in Asia, where there is far less of either principal-agent or producer capture at work, the future direction of both industries is becoming clearer.
