What is thematic investing?
Thematic investing involves identifying major themes that are shaping the global economy and markets, and investments placed to benefit from those developments. The trends, which could arise from climate change, disruptive technologies or changing consumer behaviour, include forces such as globalisation, political volatility, geopolitical competition and technological change.
“These forces are broadly independent of the economic cycle, and the investment universe is huge and difficult to access via mainstream indices.” Says Jamie Mills O’Brien, Portfolio Manager, abrdn.
Growing importance
Jamie believes that markets are currently being driven far more by these powerful structural growth trends than in previous market cycles. He adds that “in a world where economic growth is slowing, the importance of these structural growth themes across consumer, financial and industrial spaces – not just in technology - is probably going to go up, rather than down”.
Unsurprisingly, against this background, Blair Couper, Investment Director, abrdn, says that institutional practitioners increasingly understand the value that thematic investing can add to portfolios.
“We don’t think you can look at the energy transition without analysing the impact of transformational technology. Technological change, for example, is driving many of the green solutions that are going to help us achieve net zero”.
Jamie Mills O’Brien, Portfolio Manager, abrdn
Thematic investing is also gaining in popularity with investors. According to the research company Morningstar, that’s because “many investors don’t feel the traditional investment lens fully captures the drivers of growth in the modern globalised world and increasingly favour a thematic approach”. (1)
Trends transforming economies
Examples of the trends that are driving thematic investing include the energy transition from fossil fuels to renewables, the rise of transformative technologies such as generative artificial intelligence (AI), the ageing of societies, friend-shoring and geopolitics, and the impact of climate change.
Jamie points out that the themes often overlap: “We don’t think you can look at the energy transition without analysing the impact of transformational technology. Technological change, for example, is driving many of the green solutions that are going to help us achieve net zero”.
Differentiation required
Blair, meanwhile, believes it is important to recognise that not all themes hold the same potential to disrupt. Thematic investors need to be able to forecast just how a theme will impact societies and economies, the likely winners and losers, and whether the trend offers a realistic investment case.
He cites the example of home delivery of food – a sector that has seen explosive growth in recent years, but that has not generated significant returns on capital for the businesses involved.
Space exploration could be another huge trend in the future, yet it is difficult to envisage how the theme will develop and exactly how businesses will profit from it.
AI provides a good example of an enduring theme that is already having an impact, and where it is possible to identify businesses that should potentially profit. However, Jamie argues there is a risk “that we overestimate the monetisation potential of AI in the short term, and we underestimate it in the long term”.
Another challenge in thematic investing is that only a very small number of companies appear to be profiting from AI currently. Jamie and Blair see the risk that its development will not be linear, with scope for it to be overestimated in the near term. Nonetheless, they believe that the number of winners could increase in the coming years.
In addition, the impact of AI is not confined to suppliers of the technology, such as semiconductor manufacturers. Other industries are also being affected. The growth of AI is, for example, driving huge demand for energy. That is driving earnings growth among those manufacturers of electrical equipment that are involved in increasing the capacity of the energy grid to meet the growing demand.
In conclusion, in an increasingly globalised and independent world, thematic investing is an attempt to find a way to identify investment opportunities versus the traditional focus on geographic markets and sectors. When paired with a focus on finding the highest quality companies from each theme – or what Blair and Jamie term ‘serial value creators’ rather than disruptors (which often rise as a result of hype cycles).
However, there are disadvantages. Morningstar points out, for example, that “thematic funds, particularly those served in an ETF wrapper, tend to offer a highly concentrated basket of stocks—which in most cases means that they should only constitute a small portion of an already diversified portfolio”. (2) This narrow and focused nature may also mean the funds prove relatively volatile.
In addition, a thematic investment approach is only as good as the research and analysis on which it is based. Faulty analysis could, for example, result in a short-term fad being identified as a long-term structural trend.