By Maurits Pot
In a world of accelerating change and innovation, thematic investing has become a popular approach to invest in key trends. In this post we explain what thematic investing is and highlight some of the key trends that thematic strategies target. We also consider the pros and cons of this investment style.
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What is thematic investing?
Thematic investing is an investment strategy that seeks to invest in groups of securities that benefit from trends that are shaping the world. Thematic investing groups securities according to trends, ideas, and values. This approach is usually used for equity investing, but is applicable to other asset classes too.
Prior to the advent of thematic investing, investment strategies tended to focus on sectors, regions, size, and fundamental factors. When you chose stocks that belong to a theme, you won't be confined by these categories. Instead, you will focus on markets, technologies, and opportunities.
If you consider companies by theme, you don't have to worry about companies that are misclassified or operate in more than one sector. You can also consider where a company operates, rather than where it happens to be listed or headquartered.
Thematic investing is focused on the future and on the opportunities well-positioned companies can benefit from. This compares to traditional investing methods which often focus on the past and present. Very often, if you wait for a company's success to show up in the income statement, you will leave potential returns on the table. If you instead focus on the evolving markets and technologies, you can invest in companies earlier.
Examples of investment themes
Typically, an investment theme will focus on companies (and other securities) with growing markets, evolving and disruptive technologies, or structural problems that need a new approach. A theme can also focus on a vision, ideas or values.
The following are just a few examples of different categories and investment themes.
In the last decade, several transformative technologies have emerged. These technologies can disrupt entire industries, and lead to the creation of new markets and industries:
- Cloud computing
- 5G technology
- Robotics and automation
- Blockchain technology
The world has a number of major challenges which companies are attempting to solve. Ultimately, companies earn profits by solving problems, so any global challenge is an opportunity for investors:
- Climate change
- Renewable energy
- mRNA Vaccines
Demographic change leads to economic change. Groups of countries taking part in these shifts can offer opportunities. A theme can also be constructed around the companies associated with a demographic shift:
- BRICS - Brazil, Russia, India, China and South Africa.
- MINTs - Mexico, Indonesia, Nigeria, and Turkey.
- Tiger Cubs – SE Asia emerging Economies.
- Aging populations - Companies that benefit from population aging.
ESG (environmental, social, and governance) investing
Investing strategies that consider issues like ethics and sustainability are another growing category for investment products. In some cases this category overlaps with challenges like climate change, but it can also be focused solely on values and ethics. Areas of interest include:
- Clean energy.
- Transparency and governance.
- Labor relations and workplace safety.
Brand new frontiers offer more speculative opportunities. In many cases these industries are yet to find, or prove a business model:
- Space tourism and exploration
- Digital currencies
- The Metaverse
Thematic investing ETFs
ETFs are an effective way to invest in themes, and there are now hundreds of thematic ETFs to choose from. Some invest in well-defined themes like cloud computing and clean energy, while others target broader themes like millennial consumers and the Gig economy.
For most investors, managing a portfolio according to a thematic strategy is a very time-consuming task. Thematic ETFs are a more efficient approach. Thematic ETFs can be used as building blocks to create a portfolio. Typically they would be held alongside individual shares or ETFs that track market indexes.
Most thematic ETFs are passively managed, but a growing number are managed actively. This makes sense in cases where a theme cannot be clearly defined or tracked by an index.
Pros and cons of thematic investing
Thematic investing has several advantages, particularly at the current point in time. The global economy is currently in the midst of several major changes, and forward-looking investment themes are a compelling way for investors to invest behind these changes.
There are several other advantages to thematic investing:
- Investment themes tend to focus on areas of change, which offers opportunity and growth.
- By investing across a theme, you reduce single security concentration risk.
- You can avoid unwanted securities that would routinely be included in sector ETFs.
- Investment themes are not confined to sector or industry classifications, so a theme can include companies from several sectors.
There are a few disadvantages and risks that investors would be aware of:
- When an investment theme becomes very popular, a large number of new investment funds targeting the theme are often launched. There have been several instances where the launch of thematic ETFs has marked the high point for prices of securities associated with that theme. Long-term investors should avoid choosing funds based on recent performance.
- If an investment theme is too narrow, there may be a limited number of quality investments available.
- Some investment themes make sense from a marketing perspective, but don’t really offer a strong investment case. Investors should be wary of vague themes, promoted with buzzwords and hype.
The world is undergoing a period of unprecedented transformation. Thematic investing offers investors the ability to benefit from major structural changes that are occurring in the world. This can serve as a compelling and diversified approach to growth investing. As is the case with any investment strategy, thematic investing does come with certain risks that investors should be comfortable with.
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