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Thematic Investing: Funding the future

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23 Jun 2022

Investing in new and developing megatrends is far from a passing fad, discovers Andrew Holt.

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Investing in new and developing megatrends is far from a passing fad, discovers Andrew Holt.

The Covid pandemic enabled some investment trends to thrive. Among them, was thematic investing, which investors committed to in massive numbers. Indeed, thematic assets under management worldwide exceed $800bn (£653bn) up from $255bn (£202.7bn) at the start of the pandemic, according to Morningstar.

Thematic investing is a grand title for a big idea, one which ultimately focuses on megatrends. It takes changes in society, applies them to an investment crystal ball and aims to make financial gain on those trends coming to fruition.

“Megatrends are powerful, transformative forces that can change the trajectory of the global economy by shifting the priorities of societies, driving innovation and re-defining business models,” says Evy Hambro, global head of thematic and sector-based investing at BlackRock.

“They can have a meaningful impact, not just on how we live and how we spend money, but also on government policies and corporate strategies,” he adds. “Identifying the potential for structural change and investing in expected transformations early can be a key driver of successful investing. This may be an opportunity for investors to position their portfolios for long-term growth potential.”

In other words, investing in the future is key to securing their future. “Megatrends are long-term structural forces and we expect them to evolve over time. For instance, in 2016, the emerging global wealth megatrend primarily focused on China’s rise,” Hambro says.

But since then, this wealth megatrend has expanded to incorporate the emerging middle class in southeast Asia and other developing economies. “Rapid urbanisation has similarly incorporated the advent of smart cities and on-demand business models, along with infrastructure needed to support emerging megacities,” Hambro adds.

The pandemic influence

As a style of investing, it left its mark during the pandemic, especially in focusing on particular themes. “The Covid pandemic made our world suddenly need to become more digital, at the same time as substantial investments were made into life sciences and healthcare, which quickly increased the interest in these megatrends,” says Stephane Mattatia, head of thematic indexes at MSCI.

In addition, the ubiquitous influence of ESG was apparent. “There was also an acceleration of the trend for people wanting to assess how their investments affect the environment and society, which boosted the interest for ESG-linked thematic,” Mattatia adds.

Sustainability has been a theme for Evy Hambro. “We saw sustainable themes as being particularly resilient in this environment, due to the long-term structural growth drivers behind the companies we invest in, coupled with the sustainable characteristics of these businesses.”

Aanand Venkatramanan, head of ETFs at Legal & General Investment Management (LGIM), observes that restrictions resulting from the pandemic accelerated certain trends that were already underway. “To name a few, since the pandemic we have seen an increased adoption of the cloud, higher online retail volumes, a shift towards decentralised, remote healthcare and an increased focus by companies towards global supply chain resilience, inventory optimisation and automation installations.”

Here and now

So, what megatrends are investors focusing on? “Now that the pandemic is fading, we are seeing more interest in thematic at the crossroad of environment and technology, like future mobility, water and smart cities, which bring together the pre-pandemic priorities with the opportunities in a changed world,” Mattatia says.

Predictably, inflation is another example that has grown in prominence as a global trend for investors. Hambro says the attraction of ESG themes will be a central thematic going forward. “Sustainable thematic funds not only allow clients to access the long-term structural shifts that we are witnessing globally, but also have further consideration to those shifts that are necessary for the transition into a more sustainable world,” he says.

And as the world becomes more populated, prosperous and demanding on the planet’s resources, the pressures of climate change and resource scarcity rise. “We currently see climate change and resource scarcity as a key megatrend that we believe will disrupt all aspects of our everyday life. We are seeing regulatory, societal and economic support, as we look to transition to a net-zero world,” Hambro says.

“Sustainable thematic funds invest in companies which are actively combatting these global sustainability challenges, within their respective themes,” he adds.

There is no doubt that assets in sustainable investing strategies have grown at a rapid pace. “This demand looks poised to accelerate,” Hambro says, “driven by societal and demographic changes, increased regulation and government focus, and greater investment conviction. Within the space, the number of related products has exploded.”

New themes

The range of themes is potentially endless, as the world we live in is one that is constantly changing, resulting in a rise of new, and potentially exciting, themes for investors to plug into. “Consumer preferences are forever changing, societal forces are continually wanting to make humankind more efficient or more sustainable, and technology is helping us to adapt to these new habits in a cheaper way,” Hambro adds.

Therefore, it is important, and arguably central, to identify those trends which are underestimated, but likely to be the ground-breaking inventions and ideas of the future. “To identify these, we look to the megatrends driving change in the world as we know it for guidance of what is happening all around us,” Hambro says.

BlackRock, therefore, identifies five ground-breaking megatrends that are beginning to unfold that will shape the future: shifting economic power; climate change and resource scarcity; technological breakthrough; demographics and social change; and rapid urbanisation.

Venkatramanan highlights LGIM’s thematic focus. “We focus on technology, demographics and energy and resources,” he says. “We believe that themes emerging from these areas are positively impacting our lives, our work and our society in a structural and foundational way, by leading to behavioural changes and creating efficiency gains that were once unthinkable, for example, warehouse and logistics automation and mobility electrification.”

Looking into the future

The implications of these megatrends could indeed be as significant as the invention of electricity, which sparked the second industrial revolution in the early twentieth century, or the advent of container shipping that later steered the globalisation era.

In both cases, the global economy experienced significant structural shifts, opening new growth opportunities in several industries, and catapulting early adopters to global leadership. It is for this level of change that investors ideally would like from a megatrend.

Aanand Venkatramanan says there is an interesting megatrend in greater development of robotics. “One long standing source of innovation, robotics and automation is likely to continue to transform our lives and disrupt an increasing number of industries for years to come. The broad set of available technologies, from software and cloud to robots and machine intelligence, can allow warehouses to become “smarter” and let automation facilitate tasks and improve safety,” he says.

The logistics and last-mile delivery markets also remain key areas of development, Venkatramanan says, as providers optimise their networks to manage peak volumes and gain efficiencies, spurred by lower margins and higher competition especially in the food and grocery sectors.

Big data

Elsewhere, the digital payment theme continues to be underpinned by strong growth drivers such as the secular, ongoing shift away from cash transactions and the rise of e-commerce, he says. “In the inter-connected world we live in, in which we are surrounded by Internet of Things devices, artificial intelligence and big data, cybersecurity will likely continue to be a major area of investment across all industries,” Venkatramanan says.

Data here proves the point. According to Cybersecurity Ventures, global spending on cybersecurity products and services is expected to grow to $1.75trn (£1.43trn) cumulatively in the five years to 2025, up from $1tn (£800bn) cumulatively between 2017 to 2021.

Venkatramanan also says healthcare remains another important theme, as with the outbreak of the pandemic, not only have we become more conscious of the importance of our health, but also aware of the pressure that hospitals and healthcare staff are facing.

“This has accelerated the need to deploy healthcare technology that can improve efficiency, reduce costs and make healthcare more available and affordable to all,” he says.

Hambro also says the energy and resources megatrend offers potential growth opportunities. “Given the narrative on sustainability and climate change, the size of government support and the technological improvements that have the potential to make renewable energy more reliable, scalable and cost competitive.”

On a longer-term outlook, Venkatramanan says: “Thematic investing involves seeking companies that are driving innovation and avoiding those that could be disrupted. Innovation arising from trends in technology, demographics, and energy and resources can unlock opportunities in areas that may offer long-term growth potential.

“Goals associated to the energy transition are a great example of the large scale and long timeframe of thematic investing,” Venkatramanan adds. “According to the Intergovernmental Panel on Climate Change, through to 2050, between $1.6trn (£1.27trn) and $3.8trn (£3trn) in new climate investment is required for the supply side of the global energy system.”

Will it last?

It is interesting that Venkatramanan puts the case for thematic over a longer-term horizon, as one big question mark over the- matic investing is its long-term viability. “Most thematic funds don’t beat global equities over longer periods,” says Kenneth Lamont, senior fund analyst for passive strategies at Morningstar.

Highlighting the point, in the past 15 years, more than three-quarters of thematic funds have closed, reveals Lamont. But to suggest thematic investing does not correlate over the longer term is not correct, Mattatia says. “Megatrend thematics are looking to capture long-term innovation and disruption. A short-term investment in megatrends can of course be profitable, as these portfolios are often volatile, but most institutional investment can focus on gaining value from investing in long term, structural, transformative shifts.”

BlackRock does use its thematic investing over shorter time-scales. “Within our thematic portfolios, we invest over the medium to long-term with a three to five years investment horizon in mind,” Hambro says. “Investors have traditionally thought about portfolio construction in terms of geographical and sector allocations. However, with thematic funds growing rapidly in popularity and investing globally and across sectors, investors are increasingly asking how these funds fit into broader portfolios.”

BlackRock’s investment thesis is that investing in companies’ whose earnings are set to benefit from a theme, should lead to outperformance versus broader equity markets.

“We believe strongly in the ability of thematic investing to add value in a portfolio. The optimal approach to adding thematics into client portfolios depends on the investor’s investment objective and preferences,” Hambro says.

The thematic trend is without doubt one that is growing and looks far from being a pandemic fad. There were a record 589 thematic launches last year – according to Morningstar – more than double the previous record of 271 in 2020, taking the total to 1,952. “We have seen some significant change in investor interest, with the debate changing from deciding whether to invest or not, to investors looking at how they can best invest to utilise thematics,” Mattatia says.

Just the beginning

The key to success, of course, is connecting to the correct trend, which usually results in real long-term benefits for investors. The first thematic fund, according to Morningstar, was The Television Fund, launched in 1948 by Chicago-based Television Shares Management, which was designed to benefit from the rapid growth in the TV industry. And it certainly achieved that.

The fund plugged into new trends expanding out its scope to become the Television-Electronics Fund and in 1970 broadened out further again, as the Kemper Technology Fund, seeing a great deal of success over decades as TV and technology kept growing. Investors seek to unlock the modern equivalent megatrend.

And although it has been around for some time, with a committed segment of investors clearly seeking new megatrends in which to invest, it is still an approach that has to be fully embraced by investors.

“We are still at the beginning of thematic investing’s journey towards widespread adoption,” Mattatia says. “The range of measurable trends is still evolving, and we are adding further global macro trends to our indexes and tools for investors, and we expect to be constantly checking the relevance and completeness of our assessments.”

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