The Pitfall of Thematic Investing

by: Mike Steinhardt

It’s tempting for many people to do thematic investing.  Listen to smarties appearing on financial entertainment and it’s almost impossible to miss. 

Sometimes it’s addressing macroeconomic themes like slowdown or recession and you get treated to how smart it is to be “defensive.”  Note that I don’t intentionally go defensive.  Similarly, when the economy starts to pick up, you might hear about “early cycle recovery” picks.  Note that I don’t intentionally go aggressive.

Over the past few years, we’ve been treated to some fun themes… like buying ethanol stocks because President Bush and Congress supported it (oops) and the bird flu trade - buying stocks that would help us deal with pandemics (oops), and the terrorist trade - buying stocks in security companies (oops), and the Katrina trade - buying stocks in plywood, shingles and other home construction supplies (oops).

Themes are all about fads.  Often, other than the guys talking about the theme and why these stocks make them sound so smart, the strategy has no basis in sound investing.  This is about speculating and trading, not investing.  You really need to evaluate how well thematic bets actually work out and make sure you are paying attention for when the fad fades or isn’t mentioned by a gazillion other smarties on TV.

I recommend that you work on finding good stocks first and then figuring out whether they are getting a boost from a theme that might last for a while.  Coming up with a theme and then trying to find stocks that fit that theme is not a good idea.