Introduction to Thematic Investing
Introduction to Thematic Investing For decades, benchmarks have served a key role within the investment management industry. Both at asset allocation level and at fund level, portfolio management has often been structured around the process of either adhering to, or deviating from a benchmark in order to enhance returns or limit downside risk. Proponents of this standard industry model argue that a benchmark provides both a useful starting point for the construction of a portfolio, as well as a yardstick by which investors can measure their performance. But is this approach to investment management, where capital is allocated with reference to benchmark index weightings, suited to today’s rapidlychanging world in which technological innovation is disrupting traditional business models, global demographics are shifting and valuations across the world’s financial markets are near all-time highs? One of the fundamental flaws of benchmark investing is that it tends to
focus on past successes and can fail to incorporate emerging trends and forwardlooking perspectives. As a result, it can lead investors in the wrong direction at times. For example, consider the FTSE AllShare Index, which many UK equity portfolio managers are benchmarked against. Examine the top holdings within this index, and you’ll see a number of wellestablished companies across the oil &
gas, financial and tobacco industries. There’s no doubt that these companies have enjoyed tremendous success in the past, but with the increase in alternative fuel sources, the extraordinary growth of ‘FinTech’ and changing attitudes towards health, are these companies the best investments to be holding over the coming years and decades?
Similarly, at asset allocation level, benchmark investing is problematic. For years, the standard industry asset allocation for moderate-risk retirement portfolios was an allocation of 60% to equities, and 40% to bonds. This benchmark allocation, which has been widely adopted by investment advisers in the past, is designed to provide relatively stable long-term returns, with bonds
providing portfolio protection when equities fall. Yet with bond yields near all-time lows and bonds set to underperform as interest rates rise, is this model still appropriate? Many investors we have spoken to are now beginning to question whether this allocation is still relevant in today’s market environment, and this is reflected in our portfolios.
With the world experiencing so much change, there is now a growing school of thought that benchmark investing is out of date, and that there are better alternatives for those looking to capitalise on the future investment opportunities created by change. One such alternative is thematic investing. With a focus on long-term structural trends and powerful seismic shifts, thematic investing offers a unique approach to investment management and enables investors to break free of the traditional approach to portfolio management and capitalise on global megatrends. This guide takes a closer look at the benefits of thematic investing and highlights ten key themes that we believe offer compelling long-term investment potential.
What is Thematic Investing? Broadly speaking, thematic investing is an investment strategy that aims to identify and profit from long-term structural trends that are shaping the world. “In a rapidly changing business environment, the winners will be those that anticipate trends and take advantage of new opportunities.”- Willis Towers Watson Ultimately, the approach aims to capitalise on changes that are occurring within our world and to generate powerful investment returns from long-term growth stories. Because thematic investing focuses on future change and bigpicture ideas, the strategy offers a different approach to investment management. Whereas benchmark-investing approaches tend to assume that past winners will continue to win, thematic investing seeks to anticipate new trends, embrace change and take advantage of future growth opportunities. Rather than focus on past performance, thematic investing looks to the future and aims to capitalise on long-term structural change. Ignoring market capitalisation, geographical boundaries and style biases, it breaks free from the traditional strategic asset allocation model, and offers an extremely flexible approach to portfolio management. As such, not only could it help investors generate strong longterm returns, but it could also provide diversification benefits and reduce overall portfolio risk. Furthermore, the typical asset allocation of a balanced portfolio will remain static over time. Our thematic portfolio’s asset allocations are flexible, are not tied to any sector or geography, and can be adjusted to suit market dynamics.
Identifying powerful long-term investment themes is the first step in the thematic investment process and the most prominent themes are generally centred around social, demographic and technological change. The world’s ageing population, advances in technology and environmental protection are three examples of dominant themes that are having a significant impact on our world today and are likely to continue having an impact in the years ahead. The basic premise of thematic investing is that by understanding the investment opportunities associated with these kinds of themes, investors can increase their chances of generating above-average returns over the long term. It’s worth noting that often, themes do not exist in isolation. There can be significant overlap between key themes and the most profitable ideas often require multiple themes to emerge simultaneously. For example, the world’s ageing population is linked to the increasing interest in health and wellness across the world. Similarly, robotics is linked closely with other areas of technology such as artificial intelligence (AI) and The Internet of Things (IoT). So, it can pay to focus on interconnected ideas when following a thematic approach.
“In our experience, the most attractive opportunities are found when multiple themes converge and reinforce one another.” McKinsey & Company
The Advantages & Disadvantages of Thematic Investing
• It helps investors stay focused: The
longer-term nature of a thematic approach can also be beneficial to investors because it reduces the focus on short-term market noise. As a result, it can help investors stick to their investment strategies • It offers diversification benefits: Yet as
Thematic investing offers investors a number of benefits. Here are four key advantages of the investment strategy:
• It’s an intuitive approach to investing: It’s
easy to understand and makes sense. As a result, it can empower investors as they can put their money into areas that interest them and ideas and trends that they are already familiar. This makes investing much more relatable. • It offers the potential for strong long-term
returns: As a strategy that aims to invest in the success stories of tomorrow, the approach offers investors the opportunity to generate strong investment returns over the long term. When executed properly, thematic investing could help investors capitalise on disruptive technologies, demographic shifts and changing consumer behaviour patterns. “Investors who are willing to follow the insights of such longterm themes over multiple business cycles can benefit from potential mispricing created by the typically shorter-term focus of financial markets.” – UBS
well as providing investors with the opportunity to generate long-term capital growth, thematic investing can also offer investors diversification benefits. This is because the approach tends to focus less on the economic cycle and more on long-term structural forces of change, and as a result, thematic portfolios often have a low correlation to other mainstream investment strategies. As such, the investment strategy can be used to hedge other portfolio risks and reduce overall portfolio risk. One particular way the approach can help diversify a portfolio is by enhancing geographical diversification. The primary goal of thematic investing is to invest in companies that will benefit from long-term structural growth opportunities. Where those companies are based or listed is of less importance. With less geographical restrictions than a traditional benchmarkoriented portfolio, a thematic portfolio is likely to have exposure to a broad range of economies, both developed and developing, and this can provide valuable diversification benefits during periods of market stress.
Of course, just like any other investment strategy, thematic investing is not perfect. The investment style does have its drawbacks and, therefore, won’t suit every investor. Here are three disadvantages of the investment approach: • It’s a long-term strategy: Thematic investing is most definitely a long-term investment strategy. The approach is designed to capitalise on long-term structural trends and these trends can take time to play out. Thematic investing requires significant patience and discipline, and as a result, it’s unlikely to suit those with shorter-term investment time horizons, or those looking for fast gains. • It can underperform at times: Investors should also be aware that due to its low correlation with traditional investment strategies, a thematic investing strategy may underperform global equity benchmarks at times. As such, the strategy may not be suitable for those who are unable to tolerate significant deviations from mainstream equity benchmarks. • Generating profits is not always straightforward: Another key challenge of thematic investing is that the successful identification of themes does not always result in successful investment outcomes. History is littered with ideas that failed to take off and some themes may not generate profits. Similarly, there’s the risk that companies exposed to certain trends will not perform
well. Successfully executing a thematic strategy involves correctly identifying structural shifts, then identifying companies that are well placed to capitalise from these shifts, and then lastly, timing the investments so as to enter the theme early enough to capitalise fully on the theme’s potential. It’s not always a straightforward process. As always, investors should familiarise themselves with the investment strategy to ensure that they are comfortable with the risks before investing.
Key Investment Themes Identifying powerful long-term investment themes is a key step in the thematic investing process. Environment & Sustainability As our world evolves, societal, government, regulatory and fiduciary pressures are now driving change on a range of environmental and social fronts. This trend has gathered momentum and is likely to receive further impetus from governments. As companies respond and increasingly shift investment to address global pressure points, the opportunity to own businesses that create a positive impact on society and the planet is broader than it ever has been in public equity markets. As thematic investors, we have always adopted an awareness of sustainability issues. ESG and sustainability are likely to be embedded in investment philosophies for years to come. Robotics & Artificial Intelligence One particular niche area of technology that looks to have incredible potential is robotics. While robotics is not a new field, technological advances in recent years have given rise to a new generation of intelligent robots that are significantly more advanced than robots of the past. Today, robots can sense the environment that they are in, interact and work with humans, and perform sophisticated tasks across a number of industries. The demand for robotics, automation and machine learning from global industries and supply chains has been exacerbated further by COVID-19.
Healthcare, Bio-Tech & Living Longer
Disruptive Technology
Developed and emerging economies are witnessing increases in life expectancy and it’s estimated that by 2050, there will be more than 2 billion people across the world aged 60 or older – more than twice the number of people of this age in 2000. Naturally, this increase in the age of the global population is likely to have a number of ramifications, including an increase in the demand for healthcare. Awareness of technology advances and medical discoveries aided by the availability of cheap genome sequencing make bespoke preventative medicine a viable alternative to generic treatment-based drugs. For astute investors, the world’s ageing population and broader issues of healthcare and its availability is likely to provide a wide range of investment opportunities.
Over the last ten years, advances in technology have had a dramatic impact on our lives. Yet with technological innovation increasing at an exponential rate, the next ten years has the potential to be the greatest technological revolution in history. From intelligent machines that can teach themselves through the power of artificial intelligence, to selfdriving cars that can communicate with other vehicles, technological advances are likely to have a powerful impact on society in the years ahead. The technology sector looks set to provide investors with a large number of exciting investment opportunities. The need to be aware of the disruptive impact of technology is key and there is clearly potential for disruptors to be disrupted themselves. The impact of online shopping on traditional retail, the shift towards home working and the use of cloud technology are ongoing as we emerge from COVID-19.
Smaller Companies (both public and private)
Infrastructure
Smaller companies tend to be at an earlier stage of the business life cycle. As a result, they can offer greater potential for growth. Indeed, many studies have shown that in the past, the strongest long-term stock market returns have actually come from smaller companies and that small-cap stocks have consistently outperformed large-cap stocks. While the UK is home to a large number of disruptive smaller companies that have huge growth potential, there are many other regions across the world that offer investors growth opportunities in the small-cap space. As Featherstone is unconstrained by size (not too big), we have a natural preference for smaller companies in our thematic approach.
Every country in the world relies heavily on infrastructure, yet across both developed and emerging economies, there is a need to build more infrastructure following years of under-investment after the Global Financial Crisis. The reality is that in many parts of the world, the inadequate provision of critical infrastructure such as safe roads, dependable rail networks, effective communication networks and reliable electricity grids is a significant risk to communities. With a global population that is continuing to surge, the demand for robust infrastructure assets is unlikely to subside any time soon. Additionally, greater adoption of cloud computing is an invisible yet increasingly important form of infrastructure. As an asset class, infrastructure can offer stable long-term returns.
Featherstone’s Approach to Thematic Investing Our clients’ portfolios adopt a multi-manager approach to thematic investing. We believe that a portfolio consisting of various specialist fund managers based around the world, and focused on specific themes, is likely to outperform the generalist approach to wealth management. Featherstone is part of a group founded in 1999 to manage the investments of a single family. Our investment team favours a more flexible approach to investment management and looks to actively allocate capital across a broad range of themes, geographies and asset classes. Leveraging significant industry experience, our team identifies and carries out due diligence on some of the world’s most specialised funds, in order to provide our clients with access to world-class investments that few private clients typically have exposure to. The world in which we live in is dynamic and changing continually. There is no doubt that the world in ten years’ time will look different to today due to advances in technology,
changes in consumer behaviour and demographic shifts. As such, the standard industry model of benchmark investing, which essentially looks backwards, may not be the most appropriate investment management model going forward.
focuses on big-picture ideas, it can offer investors the chance to profit from powerful long-term trends, while also providing portfolio diversification benefits due to its low correlation with traditional investment strategies.
Thematic investing offers a different approach to investment management as the strategy embraces the view that the world will look different in the future and seeks to capitalise on the investment opportunities created by change. A forward-looking approach that
Investing has always been, and will continue to be, shaped by megatrends that impact the world significantly. Looking ahead, secular trends will provide compelling investment opportunities for those who are willing to take a long-term view and focus on the big picture.
Featherstone | Old Brewhouse | Yattendon Estate | West Berks | RG18 0UE | www.featherstonepartners.co.uk Featherstone is a trading name of Featherstone Partners Limited, Old Brewhouse, Yattendon, Berkshire, RG18 0UE, which is Authorised and Regulated by the Financial Conduct Authority (799741) and registered in England (Company Number 11039522). This document is not intended to constitute an offer to sell or an invitation to make any investment, nor should it constitute advice as to whether a particular security or financial instrument is appropriate for you and meets your financial objectives. Information and any opinions expressed have been obtained from or are based on sources believed to be reliable, although accuracy cannot be guaranteed. No responsibility can be accepted for any consequential loss from the use of this information. The value of all investments can decrease as well as increase. Capital is at risk.