Thematic investment risks

THE FBM KLCI fell 5.2% month-on-month in January – not exactly the start to 2025 that investors were expecting following a great 2024.

In fact, this is the worst start for FBM KLCI in the past 30 years.

The last time it was this bad was in 1995 following the super bull run between 1990 and 1994.

There are various reasons for the sharp fall last month such as tariff declaration by US president Donald Trump on Canada, Mexico and China, as well as the emergence of DeepSeek which is reshaping the AI narrative.

Both issues specifically impact emerging markets, including Malaysia.

If we credit 2024 FBM KLCI’s market outperformance to the thematic play of AI-driven sectors such as property, utilities, technology and semiconductors, then 2025 may well be the year where it may under-perform for the same reasons.

Thematic drivers of the economy and stock market while important catalysts, should not be the only focus of policymakers and investors. Otherwise it runs the risk of being an all or nothing scenario.

Age, risk and thematic investing

An elderly friend of mine who is a fairly experienced investor has been active in the stock market even before 1997. Some time last year, he sought my view about YTL Power.

He had been told by a “celebrity” remisier to buy the stock when it was RM2.50. At the time, he was sitting on a six-figure paper profit as the share price was hovering around RM4.50.

I told him that due to the AI theme and Nvdia rallying to dizzying heights, YTL Power was the flavour of the day.

While there was possibly some more upside, from a fundamental perspective, it was time to take profit. A few months later, YTL Power scaled above RM5. He contacted me again but I told him I could not advise him further because if he had listened to me the first time, he would have missed out on the additional profits.

I ended the conversation by sharing that at his age, he should avoid thematic investing as there is a fair amount of volatility and requires constant monitoring. If the tide turns, the fall may be fast and furious. I have not heard from him since.

I am sharing this story because thematic investing is so exhilarating that it captures everyone’s interest regardless of age and background.

The hype around a particular theme which may generate windfall profit for investors is captivating. Whether it is a play on human greed or simply endless optimism, it is an adrenaline rush.

Expert or not, overnight you will see the blossoming of the investment community attracting all walks of life.

Speculative mania

There has been many phases of speculative mania, including the “Tulip Mania” in 1637, the South Sea Company collapse in 1720, Wall Street crash of 1929, the Asian financial crisis in 1997, Dotcom bubble of 2000, global financial crisis in 2008 and others.

Thematic investing largely latches on these mania.

When investors rush into a particular asset class, stock or theme in droves, that is when irrational exuberance starts to appear.

Most of the time, it doesn’t end well. This is especially so when investors justify investment decisions with the phrase, “this time it’s different”.

Short-term gain, long-term pain

There are many schools of thought when it comes to investing. For example, the more widely known overarching styles would be momentum trading, value investing and thematic investing.

It is very hard to pinpoint which is the best method.

Essentially, it is more of the function of time horizon rather than purely a matter of competency that makes these investors successful.

To put it in context, if you make quick huge returns from investing, surely you would be more confident and take bigger risks to try and replicate the success.

It is unlikely you would sit on the winnings and be content with what you have achieved.

That is human nature. Whether it is greed or optimism that drives your investment decision is irrelevant. Past successes will spur you on. The only time you will stop is when you meet with failure.

Value investing, on the other hand, relies on the time horizon of investment to achieve supernormal returns. It is likely incremental for a large part of the investment period but before you know it, the power of compounding is reflected in your gains years later. You will never get rich overnight being a value investor, but you may very possibly get filthy rich over decades.

This has been proven over time and throughout history.

Simply put, it is short-term gain, long-term pain versus short-term pain, long-term gain. Patience and discipline outperform eager brilliance.

Asset allocation is key

Although our economic history is filled with painful lessons, nothing has really changed except the form and manner.

In the past, the mania was related to flowers. The next major crash could possibly come from cryptocurrency.

While we cannot run away from market cycles, there should be some wisdom when investing in the stock market. Asset allocation and risk diversification are of paramount consideration.

Even if you choose thematic investing (which is not wrong), building a diversified portfolio rather than a concentrated bet within the same theme is a prudent move. That way, the risks of thematic investing can be minimised.