Thematic investing: Moving away from the traditional portfolio

There are plenty of investing theories that can be put into practice when it comes to managing a portfolio. For example, the old rule of thumb is that equities and bonds should be held 60:40. And in the case of pensions, younger investors can hold more equities while they can afford to take greater risks, but should gradually shift to bonds as they approach retirement as these are considered less volatile. However, many experienced investors feel that these tried-and-tested strategies aren’t always the way to gain decent returns. 

When it comes to constructing a traditional portfolio, managers often concentrate on specific countries or sectors 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, growth stocks were the order of the day, and still are — US tech giants Apple, Amazon, Alphabet, Microsoft, Tesla, and Facebook continue to dominate and outperform the rest of the market. But experience shows us that what worked well in the past may not do as well in the future.

Consequently, money managers are constantly on the lookout for alternative ways to construct a portfolio. This is where thematic investing comes in. But what is it?

Thematic investing is based on structural trends

Thematic investing isn’t confined to 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.

Investors traditionally have limited exposure to these themes as part of a portfolio’s growth allocation, but thematic investing allows specific themes to be more precisely targeted. This can result in a riskier portfolio as the holdings will be concentrated around that specific theme, however, this is 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 they keep it as diverse as possible, thereby reducing risk should a certain trend fail to pan out? Or do they take the risk and focus on a specific theme, increasing profit potential if they do pick a winner? 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 completely replace fossil fuels in the future. Some thematic investors would put together a portfolio including companies operating in all these sectors. Others may look to concentrate in a particular field, but what if that doesn’t work out? What if all these alternative energies get swept aside, or are even just marginalised by breakthroughs in other technologies, such as nuclear fusion?

Picking stocks for a thematic portfolio

Typically, when choosing stocks for a thematic portfolio, there will 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 hard 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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