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Market Update - Thematic investing - a move away from the traditional portfolio


Market Update

Thematic investing - a move away from the traditional portfolio

When it comes to money management there are an abundance of investing theories that can be put into practice. The old rule of thumb is that investors should hold a mixture of equities and bonds typically in the ratio of 60:40. Younger investors may want a higher weighting of equities in their portfolios as they can afford to take greater risks. Then, the closer one gets to retirement, there should be a gradual shift towards bonds which are generally considered to be less volatile than equities over time. This strategy has worked out well over the past seventy years or so. But will it continue to provide a decent income in retirement? There are many experienced investors who worry that it won’t. And who can blame them when both bonds and many global stock indices are trading around all-time highs, and offering precious few opportunities to buy on dips?

Changing emphasis

When it comes to constructing a traditional portfolio, managers often concentrate on specific countries, or sectors, that they feel could outperform. Ten to fifteen years ago, many funds were recommending overexposure to Brazil, Russia, India, and China, known as the BRICs. A few years later and growth stocks were the order of the day. And they still are as a small group of US tech giants, namely Apple, Amazon, Alphabet, Microsoft, Tesla, and Facebook, continue to dominate and outperform the rest of the market. But experience shows us that what may have worked well in the past may not do as well in the future. Consequently, money managers are on the constant look-out for alternative ways to construct a portfolio. This is where thematic investing comes in. But what is it?

Structural trends

Thematic investing doesn’t confine itself by concentrating exposure to a particular country or sector. Instead, it seeks to identify long-term structural trends which could have a transformative effect on global economies. These trends tend to be most powerful where new innovations prove to be highly disruptive and thereby provide significant growth potential. Current opportunities can be found in technologies that look likely to frame our future world. Such areas include robotics, alternative energy, battery technology, fintech, future mobility, autonomous technology, cybersecurity, infrastructure, education, and healthcare, including key societal changes such as ageing and our response to it. As these trends develop, they become increasingly important drivers of earnings and equity returns.

Young woman faces out of office window which reflects coloured lights from outside while using tablet device

The difference

Investors traditionally have limited exposure to these themes as part of a portfolio’s growth allocation. But thematic investing allows for specific themes to be more precisely targeted. While this can result in a riskier portfolio as the holdings will be concentrated around that specific theme, they are becoming increasingly popular. Funds in thematic schemes have more than tripled to $595 billion from $174 billion three years ago. For some, that suggests that new money is going to be too late to the party. Yet many portfolio managers still consider thematic investing to be in its early stages.

Constructing a thematic portfolio

The big issue for a manager of a thematic fund is how to construct a portfolio. Do you keep it as diverse as possible, thereby reducing your risk should a certain trend fail to pan out? Or do you focus on a specific theme, thereby increasing your profit potential should you pick a winner, but also boosting your risk? Obviously, the skill, or luck, is in identifying which technologies will triumph over others and become the dominant force. For instance, solar, wind, geothermal and tidal power are all alternative energies that have the potential to replace fossil fuels completely in the future. Some thematic investors would put together a portfolio that includes companies operating in all these sectors. Others may look to concentrate in a particular field. Obviously, the less diverse the portfolio, the higher the risk. But the returns will also be much larger by successfully backing one technology over another. Consequently, there’s the obvious temptation to back a single industry within the overall theme. But what if that doesn’t work out? What if all these alternative energies get swept aside, or even just marginalised, by breakthroughs in other technologies, such nuclear fusion?

Stock picking?

Typically, there could be many companies working towards the same objective, but in different ways. Not all will thrive, or even survive. Therefore, it is vital to carry out your own research and find out as much as possible about the management, as well as the corporate financials. This may sound like something an individual investor may be able to do themselves. After all, what’s the difference from share picking? But the truth is that many of these new technologies are being worked on by young companies that have not gone public. This can make it quite difficult to investigate them thoroughly. It also makes it particularly difficult to invest in them. For the best opportunities you need to get exposure to private markets. A thematic fund can do this while most private investors can’t. But make sure you think laterally as well. After all, it could be that there are publicly quoted companies that have direct exposure to particular thematic trends. For instance, consider businesses that provide vital equipment and infrastructure to these companies. This could be a safer alternative particularly if the provider covers several different sectors.


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