Arms, tobacco and oil are for many considered taboo investments – albeit ones with high returns. Nevertheless, being ‘bad’ has got a new appeal for some, as ‘themes’ in investing are taking precedence over traditional investment forms.
Never before has thematic investing been so popular, and yes, the main driver is the urge of many investors to put their money in safe, sustainable and environmentally friendly firms and industries. By putting firms and shares into different categories, thematic investing helps investors home in on global economic trends, as well as invest according to their personal preferences. And despite thematic investing being driven by the recent surge in green investments, it also offers the opportunity to post big bucks in controversial industries that maintain strong returns.
Thematic investing is about identifying macroeconomic trends, driven by politics, culture and demographics, or a combination of all three. Typically, the core drivers behind most thematic investment funds are population growth, rising wealth in the developing world, natural resource scarcity, energy security and climate change.
Essentially, this is a style of investing which ignores geographical boundaries and asks investment professionals to be experts in a particular investment driver or theme, rather than hedging their bets on a diverse portfolio. It is about finding companies that match a particular human need, understanding how this need is being serviced upstream and downstream, and investing in companies that are well positioned to take advantage of changing market conditions. As such, thematic research identifies trends across sectors and geographies, providing investors with enhanced alpha.
Thematic investing is about identifying macroeconomic trends, driven by politics, culture and demographics, or a combination of all three
Typically, such themes are based on political, cultural and demographic changes, which alter the market landscape. Examples include Henderson’s sustainability themes, such as Clean Energy, Health and Social Property & Finance, while new kid on the block Motif Investing offers funds such as Seven Deadly Sins and Gay Friendly, the former of which invests in companies such as McDonald’s, British American Tobacco and gun manufacturer Sturm Ruger, and the latter in firms that promote gay rights, such as BNY Mellon, Disney and Microsoft.
Targeting rookie investors
Motif Investing also offers themes of a less controversial nature, such as BRICS Building, Bulletproof Balance Sheets, Biotech Breakthroughs and Housing Recovery. Either way, its motifs have attracted attention from media and investors, who are all keen to see whether investing in something they truly care about, or consider a key trend, could pay off. Essentially, thematic investing is a way for novice investors to gain access to well performing, albeit more volatile, themes that they could normally only access via high investment fees and sophisticated advisors.
“Clients appreciate understanding the underlying structure and logic of their portfolio in terms of the seven or eight major themes that are embedded in their portfolios,” says Daniel Paduano, a Managing Director at Neuberger Berman, a major investment house. “They also appreciate that these are real world trends and not some arcane nuances of the investment business.” Neuberger Berman’s thematic investing business plays a major role in the firm, and focuses on global education and water themes in particular.
Motif’s site, with its apparently infantile theme names, belies the difficulty of investing thematically. For one, thematic investing is expensive. Buying 30 stocks through a discount broker could cost as much as $300; Motif charges $9.95 to buy or create a collection with up to 30 stocks in it. Secondly, it’s hard for most investors to execute their chosen themes on their own.
Motif allows investors to buy thematic strategies on their own with no advice, while its advisor platform provides investment advice at a low cost.
Similarly, Neuberger Berman has a strong focus on thematic investing because it presents a lower risk compared with other investments that the wolves of Wall Street clamour to get their hands on. “Thematic investing is such a large component of our business because we believe it is a leg up in controlling risk,” says Paduano. “If you get the theme right, the company has the wind at its back. It is then up to the company to execute. Second, it pushes the emphasis on investing, beyond the time frame where the crowds in the investment business are operating and this, too, can be an edge if we get someplace earlier than others.”
The key to thematic investing is maintaining a long-term outlook. Investing in trends is not something to do for a quick high-yield fix, but rather when looking for that 10-year investment that could double an investor’s savings.
“We try to identify themes that we think will have staying power in the world over a five- to seven-year period,” says Paduano. “These themes are based on movements in demographics, technology, sociology or political changes. They are meant to be enduring and not just fads. Thus, for example, the rising value of water is a theme that goes across developed and developing countries and is an issue that is going to be of increasing importance.”
Despite this, thematic investing is by no means a sure-fire way to make money, as all stocks are not necessarily going to perform well and, as such, it is an investment that presents some risks. For example, while Motif’s Seven Deadly Sins theme has amounted to 24.3 percent in returns over the past year, its stocks in tobacco-producer Philip Morris have dipped significantly over the last 12 months. The assumption is that the trend is correct over the long term, thereby hedging against the lack of diversification and potential dips in performance. In this respect, thematic investing differs from typical active managers, who would build a sophisticated portfolio across sectors, geographies and investment types.
Another concern is that thematic investing sometimes misses the trend, despite having identified it. When an investment manager picks trends – such as the growth in emerging markets, technology developments, or an aspect of the environment, such as water shortages – they have to be able to populate the themes with appropriate equities to invest in. This occasionally leads to a missing link, as you can have strong ideas about a trend, but finding companies that actually capture the ideas and are of sufficient quality and liquidity can prove difficult.
Given that thematic investment can’t rely on diversification as a hedge, it is all about doing significant research. At Bank of America Merrill Lynch’s Global Research unit, Sarbjit Nahal is the Director of Thematic Investing. He has spent years monitoring global economic, political and cultural trends in order to build the best thematic recommendations. So-called ‘megatrends’ have helped the banking group identify some of the strongest investments out there, which have been popular with its investment bank and asset management clients.
“We have tackled seven ‘bigger picture’ global megatrends, which tie strongly into the enterprise-wide investment themes ‘earth’ (energy efficiency, extreme weather and climate change, waste, and water) and ‘people’ (education, obesity, health and wellness, safety and security), as well as ‘innovation’, ‘government’ and ‘markets’,” says Nahal.
This has resulted in Bank of America Merrill Lynch buying stocks in companies that give entry points to key themes such as energy efficiency, including firms dealing in automobiles, building, industrials, IT, lighting and LEDs, energy storage, and transport. This comes as a result of significant research, which suggests the growing demand for energy will lead to an energy crisis and thus drive interest in companies that offer energy-efficient solutions. However, it’s no easy feat to find the exact firm, which will gain massively from a global trend.
“One of the biggest risks is to identify a theme and then go buy a bunch of companies involved without thorough research into that specific company including a judgment as to whether the valuation is attractive,” says Paduano.
Because of this, investment banks and firms who wish to focus on thematic investing need to invest in research capabilities, first and foremost. “Themes are chosen and maintained by doing research in a broad range of subjects through reading books, journals and periodicals covering technology, science, demographics, social and political trends. This is a lot of reading away from Wall Street reports,” explains Paduano.
Themes such as water, health and energy infrastructure have all performed well for investment firms when compared to major indexes. For the long-term investor, betting on major trends could prove to be a profitable, albeit volatile, decision. And for the savvy, modern and socially conscious investor, thematic investing could be one of the best solutions out there for picking and choosing just the right stock. Seemingly, this is why the investment field has never been so popular as it is now.