Marietjie Geldenhuys, Client Portfolio Analyst, Stonehage Fleming
Thematic investing, a dynamic approach to building alpha seeking portfolios, aims to capitalise on structural trends shaping our future and playing out over many years if not decades.
These ‘megatrends’ are distinct from short-term cyclical themes and could lead to significant transformations in the global economy. As such, they might present the potential for very attractive investment returns, while complementing other more traditional investment strategies.
When identifying megatrends, we use a four-pillar approach that looks at demographics, consumption patterns, economic power, and sustainability.
While sustainability is closely associated with ‘green’ products and services, such as solar power, it really goes to the very heart of business practices across every industry.
The goal of thematic investing is to identify the key trends that are likely to develop into significant market opportunities and provide enhanced investment returns for those companies exposed to these trends. We are seeing an increased appetite for thematic investing due to the potential out-sized returns. Thematic investing encompasses a range of asset classes and is distinct from traditional market-cap based asset allocation that can overexpose investors to yesterday’s winners. Below are a few examples.
The evolving consumer
What consumers want, who, they are, and how they want to spend their money, is changing rapidly. The Asian economy, for example, had 1.5 billion new consumers entering the market over the last 10 years, and is expected to grow by a further billion consumers over the next decade, gradually turning into a 10 trillion dollar market.
There is also the global luxury market, a key allocation in our portfolios which has proven to be very resilient in the current environment of high inflation. Most companies in this sector exhibit low debt, strong growth and have both pricing power and devoted consumers.
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Automation and Artificial Intelligence
This trend maps the application of automation and artificial intelligence (AI) and encompasses companies that provide automation products, services and software that enhance business productivity. With the current trends of cost reduction and increased functionality, end-market applications are increasing dramatically. In conventional areas such as assembly, there is still a huge growth opportunity and there are more exciting, non-traditional markets such as healthcare (with a focus on drug discovery) and future mobility, such as autonomous driving.
With the potential to disrupt traditional business models, AI has been made possible by the availability of new data sets as well as the dramatic reductions in the cost of processing this data. In the field of robotics, AI is allowing robots to operate in a collaborative way, with each other and with humans in real time. An example of an important enabling technology for AI is semi-conductor equipment, which we see as a leveraged play on AI proliferation. As many automation applications are new iterations of existing technology, built by quality businesses, the multi-decade opportunities in automation can still be accessed without taking binary risks and investing with proven companies and technologies can reduce the risks significantly.
The Green Economy
This is an ecosystem that emphasises a reduction in environmental impact through recycling, resource efficiency and a transition away from the fossil fuels economy. Triggered by policy initiatives, investing in the green economy saw a speculative surge that drove up asset valuations to the point where they became less attractive. Recently, however, valuations have settled back down to more reasonable levels. Two important sub-themes within the overall green economy megatrend are resource beneficiaries and resource efficiency.
An example of a resource beneficiary is silver, which plays a key role in the solar power industry as well as in the electrification of transportation. Resource efficiency centers on new models such as leasing, of which Airbnb and Uber are two obvious examples.
Effective thematic investing is about recognising powerful and transformational themes, to complement current portfolios and implementing a strategy with greater sophistication and differentiated alpha potential.
From a behavioral perspective, it will be interesting to see if investors are more willing to stick with a thematic portfolio compared to a traditional stock portfolio during a bear market or recession. It should be easier for investors to lean into and stay invested with a theme if they understand how it aligns their capital to a megatrend, and the consequent enhanced long-term return potential that it provides.