The risks of investing in luxury through an indexed passive vehicle

Javier G. Lastra, CFA
By Javier G. Lastra, CFA
Investment Partner
May 25, 2023

In our introduction to luxury blog, we touched on the potential limitations of investing in the luxury sector through an index approach. In this blog, we delve deeper into two of these possible drawbacks, and how Tema's approach seeks to address the following issues: indices typically conflate luxury with mass market consumer companies, and the luxury sector has historically exhibited wide returns outcomes, creating lagging tail exposure.

Existing luxury indexes are exposed to mass consumer discretionary companies

We believe an index approach can be a suboptimal way to invest in luxury, due to poor index construction and lack of thematic purity. The mainstream S&P Global luxury index tracks the performance of 80 publicly traded companies within the ‘luxury company universe’ determined by S&P [1] . Its components include pure-play luxury goods companies such as LVMH but also includes what we consider to be non-luxury auto manufacturers such as Tesla, athletic apparel manufacturers such as Nike and mass consumer beverage companies such as Diageo. Together, these companies account for over 25% of the index’s weight [2] , which we feel dilutes quality luxury exposure with general consumer businesses.Slide1-Feb-01-2024-03-11-26-0819-PM

The market cap weighted nature of the index furthermore undermines the weighting of pure luxury exposure. For example, in the S&P Global luxury index as seen above, Tesla has a higher weighting than Ferrari, and Nike a higher weighting than Moncler and Burberry combined. 

While Tesla is an innovative pioneering company, we question to what extent Tesla shares the fundamentals of a luxury company, particularly when it comes to pricing power and supply scarcity. Recently, Tesla has cut prices to support volumes and market share, such that the Model Y is now cheaper than the average car for sale in the US [3] . In contrast, Ferrari annually increases prices while maintaining restricted supply.

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What is the difference between luxury goods and general consumer goods?

Luxury goods are classified within the broader consumer discretionary sector, but in reality have different characteristics that warrant distinction. At their core, luxury goods are about scarcity, craftmanship and aspirational desirability. Unlike consumer goods, luxury goods are typically less demanded for their functionality and rather more desired for their perceived exclusivity and quality. If we take the example of Nike and Hermes:

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Luxury goods offerings typically rely on quality raw materials and artisanal production methods, compared to consumer goods companies which tend to manufacture using commodity inputs at mass scale in low-cost countries. Almost all Nike shoes are manufactured outside of the United States in countries like China and Vietnam [4] . Hermes products are almost entirely hand-made in France in artisanal boutiques [5] . Distribution and customer identity are also important differentiation factors. Luxury companies tend to keenly control distribution, through a limited range of curated stores catering to affluent customers, offering them a personalized in-store experience.

“A luxury brand must have far more people who know it and dream it 
than people who buy it.”

Jean-Noël Kapferer in ‘The Luxury Strategy


These attributes underpin luxury’s premium price points and unique growth drivers that can translate into attractive earnings quality, as evidenced by Hermes’ higher gross margin and ROIC vs Nike.
 

Indices overlook large dispersion of luxury company returns, ignore fundamentals, and are ultimately backward-looking

As mentioned in our introduction blog, luxury is an industry which has historically exhibited wide dispersion of share price returns between companies. For example, looking at single-brand luxury companies’ performance since January 1st 2021, Bruno Cucinelli (+93%) significantly outperformed Tod’s (+9%) and Ferragamo (+0%) [6] . Lesser-known companies like San Lorenzo, the luxury yacht maker, more than doubled (+130%) while larger more established firms like Kering struggled (-15%)[6].

These performance dispersions show that even within pure luxury firms, there are winners and losers. Take the example of Loro Piana, now part of LVMH, and Tod's. Shoes have been Tod’s foundational products since its creation, and still account for over 75% of its revenues as of 2022 [7] . Yet Tod’s reluctance to evolve and embrace new trends has left it lagging. This has in turn allowed more innovative and progressive brands such as Loro Piana to capitalize on this stagnation, and build significant shoe market share.

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Tod’s was slow to invest in online selling and to adopt marketing tactics such as social-media campaigns and more-frequent product launches. It’s long-term CEO and majority owner Mr. Della Valle said in an interview “We aren’t going to chase millennials” [8] . On the other hand, Loro Piana has created and capitalized on current modern trends such as ‘quiet luxury’ and ‘stealth wealth’ from its appearance in popular media culture such as HBO’s hit TV show “Succession”. 

We believe luxury sector expertise is required to understand and foresee these notable shifts and innovations, underscoring the potential benefits of professional active management. Contrastingly, we feel indexes are rigid and backward looking by nature, tending to follow market cap weighting which overlooks the propensity for change and they ignore any fundamental analysis or risk management.

How Tema Luxury ETF seeks to be a solution to these challenges

Since most luxury companies are listed outside of the US without a US ADR, luxury sector access has historically been a challenge for many US investors until the recent launch of the only US luxury ETF – Tema Luxury ETF (LUX).

LUX is professionally managed by Javier G. Lastra, CFA, a seasoned industry research veteran with over 23 years of experience researching equities for banks like Goldman Sachs. The fund benefits from expertise in seeking to identify a pure luxury universe. Javier employs a rigorous bottom-up investment process focused on selecting stocks based on solid fundamentals trading at attractive valuations. This product exemplifies Tema’s mission of democratizing access to professionally managed, differentiated, institutional grade thematic ETF investment strategies.

Bottom Line

In summary, an index approach in luxury has the potential to expose investors to companies that are very different in their product qualities, business models, resulting financial profiles, and outcomes to true luxury stocks. Furthermore, the large performance dispersion in the sector underscores the need for proper risk management which we believe cannot be delivered through an index approach.

Footnotes

[1] Source: S&P Global luxury index methodology

[2] Source: S&P Global Luxury index factsheet

[3] Source: Bloomberg. (2023, April 25). Tesla drops Model Y starting price below the average US vehicle

[4] Source: Nike Manufacturing Map

[5] Source: Hermes website, ‘A house of artisans and human values’

[6] Source: Bloomberg

[7] Source: Tod’s annual report 2022

[8] Source: The Wall Street Journal, Tod’s Loafers Have Won Over Royals and Hollywood—But Not Many Millennials, 2019