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The Rise and Rise of Thematic Investing

by internationalbanker

We often like to make predictions about the future, especially when it comes to what we believe are likely to be popular trends. In today’s world, it’s often some new technology that people tout as being “the future”, such as robotics or electric vehicles, or perhaps it’s a climate-related solution, such as solar energy. And more recently, in our current age of a deadly global pandemic, one might be inclined to forecast a surge in online retail.

And why not? After all, it is always amusing to see if our predictions about the future eventually turn out to be the case. But it becomes even more interesting if an investor is willing to put his money where his mouth is and invest in the trends that are most likely to hold such potential. In the case of thematic investing, a top-down investment approach in which investors seek to align macro factors with their investing strategies, participating in just such an exercise can generate substantial returns in the long run.

A somewhat amorphous term, thematic investing refers to a specific approach to investing that focuses on broad macroeconomic themes. Historically, investing has involved research methodologies that have invariably divided opportunities along such lines as countries, regions, asset classes and individual stock characteristics. But the last 30 years have seen the new concept of thematic investing gain traction, with broad themes playing an important role in determining the best investment opportunities, particularly over a long-term horizon. During this time, it has allowed investors to capitalise on future trends by identifying macro-level themes today that are likely to flourish over the coming years and even decades. As such, thematic investors seek to gain exposure to the businesses and assets that are involved with those themes.

In doing so, they typically seek to beat the performance of market benchmarks over the long term. Typically, they will focus on equity opportunities, although recent evidence suggests that thematic investing is increasingly becoming a multi-asset strategy. It also tends to ignore geographical boundaries, instead focusing on finding companies and assets globally that can capitalise on shifting market conditions. “It’s about uncovering great stories,” JPMorgan Chase explained. “Our thematic investing strategies use a top-down view of the global economy and markets. And we’re focused on the end goal. Instead of evaluating the specific sectors, securities or security types, we hone in on achieving specific outcomes.”

Some of the most successful themes of the past include the internet, mobile phone, television and computer. Each of these technologies has broadly followed an S-shaped pattern of adoption, as popularised in the Diffusion of Innovation Theory of E.M. Rogers, whereby interest mounts slowly at first; it then accelerates as the technology becomes more widely accepted, continuing to grow at a healthy pace as mainstream adoption occurs; and, finally, it cools off as the few late-stage adopters finally come on board and the entire market is captured.

Today’s examples of popular themes include the disruptive technologies of the Fourth Industrial Revolution, such as artificial intelligence, machine learning, robotics, blockchain and data analytics. Investment opportunities that are tied to the concept of sustainability, such as clean energy and green bonds, are also garnering much interest among the thematic-investing crowd. And more recently, investors have been turning their attention towards healthcare, given the global crisis that has been sparked by the coronavirus. The MSCI (formerly Morgan Stanley Capital International) represents a suitable example of how thematic indexes can be grouped according to broad characteristics and provides three distinct divisions for its thematic indexes:

  1. Megatrends: Structural trends that could have long-term impacts on growth in a rapidly transforming world. Examples include future mobility, disruptive technology, digital economy, smart cities and Millennials.
  2. Macro-economic themes: Trends that impact the broader macro-economic environment, including rising rates, inflation, the growth of an emerging-markets middle class or global trade patterns.
  3. Micro-economic themes: Trends that emerge at the company level, including factor-based strategies that account for certain company characteristics, such as management structure, or ESG (environmental, social and governance)-type metrics, such as female representation and employee level and management level.

But there are many ways in which thematic investing can be sliced and categorised, especially given the broad range of themes of and approaches to this type of investing. For instance, another important distinction can be made between cyclical themes, which are sensitive to economic and business cycles, and structural themes, which are influenced by changes in industrial structures. In its November 2019 whitepaper “Investing in Tomorrow: A Whitepaper on Thematic Investing”, Global X ETFs, the New York-based provider of global exchange-traded funds, makes this important distinction:

  • Cyclical themes “occur at somewhat regular short—or medium-term intervals, typically based on changes in the business cycle. These cyclical trends can be mean-reverting, so that over a long period of time, they tend to converge with some average level. Examples can include asset valuations, volatility, interest rates and currency values”.
  • Structural themes “occur as one-off­ shifts that change an existing paradigm. These structural changes tend to be longer-term in nature and are typically driven by powerful forces such as disruptive technologies or changing demographics and consumer behavior”.

Given these definitions, it would seemingly make sense for thematic investors interested in longer-term exposure to place greater importance on structural themes, as they will be less affected by short-term cyclical factors. Indeed, thematic investing has gained significant popularity since the onset of the coronavirus pandemic precisely for this reason. The uncertainty that has resulted from COVID-19 seems to have driven investors towards those segments that are likely to remain resilient over the long term and are thus relatively impervious to short-term blips.

“While active equity fund flows plunged deeper into negative territory over the first five months of the year, the thematic equity sub-sector continued to experience positive flows,” Isabella Labak, a multi-asset investment director at Fidelity International, recently explained in the Financial Times. “In times of uncertainty, investors look to areas of the market that are likely to deliver with greater certainty. Investment themes, with strong structural drivers such as an ageing population or online consumerism, look better positioned than most to weather the storm.”

Of course, it is far from being the easiest task to project which specific themes will be successful decades from now. Some believe it requires a skilled understanding of how burgeoning “megatrends” are likely to be impacted by such influential factors as demographics, culture, politics, the environment, fashion and technology. “To be an investable theme for the long term, it must be supported by a rich narrative of deeper transformations in our world,” observed Hans Peter Portner, senior portfolio manager at Pictet Asset Management. And successfully adopting a thematic approach to investing requires not only successfully predicting which themes will enjoy sustained growth but also which specific companies associated with those themes are likely to prosper.

McKinsey & Company identified four key approaches that institutions can adopt to develop thematic-investing strategies:

  1. Develop thematic views within the risk limits and structures of current portfolios. Such an approach reflects a relatively low commitment to a thematic strategy.
  2. Establish a thematic overlay portfolio, or shift asset allocations and increase their durations based on house views on sector and geography.
  3. Create a single-asset-class thematic mandate with investment strategies that rely on developing forward-looking thematic views.
  4. Create a multi-asset-class thematic mandate to generate the most attractive long-term risk-adjusted returns. Of the four approaches, this represents the highest commitment to a thematic strategy.

Thankfully, we live in an age in which a number of themes have emerged that have the potential to outperform over the long run. “Global megatrends—or powerful seismic shifts—present opportunities to investors with a long-term view and an ability to identify the beneficiaries of these shifts before they become widely recognized,” RBC Global Asset Management explained in its whitepaper “Global Megatrends: Capitalizing on Tomorrow’s Trends Today”. “Whether it is the emergence of a disruptive new technology or the rise of a new middle class in emerging markets, we are continuously witnessing the impacts of megatrends as they unfold before us.”

And given the new normal to which much of the world must adjust, it only seems to make even more sense that investors make a concerted shift towards long-term structural themes that are not limited by geographies, sectors or asset classes. In these deeply uncertain times, looking to the most resilient themes over the coming years and decades, rather than simply the coming weeks and months, seems like an increasingly sound policy.


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