Many investors have discovered the benefits of using a thematic approach in choosing their investments and building their portfolios. Thematic investing is an approach that focuses on predicting long-term trends and making investment choices on the basis of the benefits that can potentially materialize from those trends. The thematic approach contrasts with the more traditional method of focusing on specific companies, sectors or commodities. Thematic investors and wealth advisors focus on identifying what are known as megatrends, and then building portfolios around those trends and the themes they embody. Here are all the essential facts you need to know about thematic investing, and how it can help you grow your wealth.
What is a Thematic Investment Strategy?
Thematic investing is a strategy that involves aligning the selection of assets with one or more broad economic or political themes. The themes could relate to specific sectors, but more often, they involve long-term, wide-ranging political and economic trends. An investor or wealth manager will start by identifying a macro-level trend. The aim is to understand these trends and try to predict how they will move in future. They then use this knowledge to inform their investment decisions. This strategy entails the careful analysis of the trends and then selecting investment targets – companies and other assets – that are likely to show significant growth as a result of their association with those trends. Global thematic investment is sector independent, cutting across national boundaries and traditional sectors.
Comparing Thematic Investing With Other Forms Of Investing
Thematic investing does have a lot in common with other approaches, particularly sector investing. The difference lies mainly in what the investor chooses to focus on. For example, thematic investing is often conflated with sector investing, but the two strategies actually approach the markets at different levels. Sector-based investing focuses on specific parts of the economy, such as commodities or technology, for example, and channels investment funds into those sectors. In contrast, a thematic investor will identify a particular economic, social, political or technological trend and then look for sectors, assets, funds and companies who are closely linked to that trend. For example, whereas a sector investor may choose to focus on the tech sector, a thematic investor might determine that the growth of artificial intelligence is a major theme for the next decade. There is a subtle but significant distinction in this shift in emphasis. The sector investor may channel funds into Silicon Valley, while the thematic investor may take a longer and broader view, focusing some investment on the tech sector itself but also taking into account other sectors and how they will be affected by the rise in AI. The latter may also target assets in the entertainment or heavy industry sectors, as both are likely to incorporate advancing AI technology into their work, making them potential growth sectors. A thematic investor might also look on the other end of the supply chain and look for producers of raw materials that will be used in the production of AI products.
Advantages Of Thematic Investing
With thematic investing, one can invest in long-term trends and themes of particular interest. It is more concentrated than asset class or sector-based investing, allowing an investor to focus closely on the desired exposure. While factor investing is historically based, with investors analyzing past trends to make their decisions, thematic investing is more forward-looking. It aims to predict developing social, political and economic trends and capitalize on them, with investors always looking to the future to predict where these trends will take them and their money.
The thematic approach to investing also helps investors to be more patient. People want to get returns as quickly as they can, and with sectors and asset classes, they may tend to anticipate growth too quickly, without understanding that investment is a long-term game. With thematic investing, this understanding is built in from the start. People know that they are dealing with the long-term trajectories of economic, social and political trends and so are more accepting of the fact that they need to settle in for the long haul and let the themes develop and unfold.
The three main benefits of thematic investing can be summed up as follows:
- Gives investors exposure to long-term structural trends.
- Positions portfolios relative to long-term risks and business models.
- Provides exposure to various themes that can be quantified, analyzed, and managed. These themes are wide-ranging in nature, allowing for more choice in terms of assets.
Disadvantages Of Thematic Investing
The critics of thematic investing tend to identify four main challenges that the strategy presents to the investor. They argue that these disadvantages can prevent the strategy from truly delivering on its promise. These are as follows:
- Thematic investing is often too theoretical and removed from practical realities. Fund managers can easily get caught up in their idea of what will be the next big trend, rather than analyzing the actual movements of the markets to make investment decisions that are based in reality. In addition, these thematic theories, in the hands of the wrong fund managers, can end up focusing on short-term fads, rather than long-term economic projections. Investments based on such faulty (or even deliberately misleading) thematic analysis can lead to losses and diminished portfolios. In short, thematic investment can easily foster both misinformed investment and dishonest wealth management practices. Investors thus need to take great care as to which wealth managers they choose to trust.
- Risk of over-concentrated portfolios: Diversity is an important quality in a successful stock portfolio. Thematic approaches can tempt investors to lose sight of the benefits of diversity and opt instead to put too many eggs in one basket. This can lead to major financial fallouts. Look at any historical example of how popular investment trends have resulted in bubbles that ultimately burst and caused both individual and macroeconomic ruin. While choosing thematic approaches in some cases, investors should still aim to maintain a healthy and diverse portfolio.
- Timing: The success of thematic investing depends heavily on an investor’s accurate reading and prediction of market timing. Put simply, the investor – or the wealth manager working on their behalf must be able to identify good entry and exit points for their investments. Unless you buy low and sell high, as you would with any other investment vehicle, thematic investing won’t offer the outstanding results you have been promised. It is very similar to any other investment strategy in this sense.
- Volatility: Thematic investments – whether direct or undertaken through vehicles such as exchange-traded funds (ETFs) can be volatile, especially if the investment is too narrow and concentrated. Again, the fund manager needs to strike a careful balance between identifying strong trends and maintaining a diverse portfolio.
A Systematic Approach To Thematic Investments
We have already mentioned how detractors of thematic investing accuse it of being too theoretical. Taking this criticism into account, it is very important to take a systematic approach to thematic investing – one that will ground the strategy in reality and ensure that the predictions upon which it rests follow well-developed models with a high degree of accuracy and reliability. Wealth managers such as those at NPW take a top-down approach beginning with the identification of trends. We scrutinize possible trends to determine their desirability as investment targets. Not all trends that seem promising in the current moment will show promise for future growth.
Once a trend is identified, we then look for sectors that are associated with that trend and are most likely to benefit from its upward trajectory. We then look within that sector to find companies and other assets that are well-positioned to enjoy the growth that their respective sectors will experience as the trend develops.
What is a Thematic ETF?
Thematic exchange-traded funds (ETF) are financial instruments that enable investors to invest in a basket of assets that are all exposed to a specific theme. These assets are associated with a wide variety of sectors, all of which have been identified by fund managers as being relevant to the specific theme. Thus, for example, an investor, instead of buying stock in a long list of companies each predicted to grow as a result of its exposure to the theme, can simply invest in a single ETF that encompasses all of those companies and more.
FAQs About Thematic Investing
- What is a thematic index? – A thematic index is an investment index that tracks the performance of companies that are tied to specific investment themes. For example, a fund manager might set up an index to track the performance of companies that are tied to developments in the fintech sector, or that provide exposure to a particular economic group, or that have high exposure to 5G and other technological developments.
- Are thematic ETFs a good investment? – Provided you choose carefully, you are sure to find an ETF that gives you the desired market exposure and helps your wealth grow. They do often have higher expense ratios than some other funds, but they are largely in line with the average expense ratio and can provide very satisfying returns.
- How are thematic trends identified? – When working to create a successful thematic index, fund managers research Megatrends with the following characteristics:
- Long-term structural (economic, social, political) trends that have strong potential to transform global economies.
- Sectors and areas of high innovation with the potential to disrupt industries and the economy as a whole.
- Clear, significant growth potential.
- Trends that are increasingly important drivers of earnings for companies and individual investors.
- Are thematic investments best for long-term or short-term results? – Thematic investing is undoubtedly a long-term approach to investment. It works by studying and projecting developments in specific economic areas – developments that will unfold over the course of many years – and therefore is better suited to investors who are prepared to take a long, careful and studied view of their financial growth, as opposed to the speculator looking for fast returns.
Nour Private Wealth (NPW) is a Canadian company with a team of wealth advisors servicing clients across seven provinces. For more information on thematic investment and other forms of wealth creation and preservation, contact us today and speak to one of our wealth advisors.