There is a lot of potential in the predicted commodities supercycle, but a commensurate amount of risk for anyone who is not an expert in these highly esoteric and volatile markets.
James Horniman, Partner and Portfolio Manager at James Hambro & Partners, gives an overview of what thematic investing means and how investors can buy into the concept without falling prey to marketing hype.
Thematic investing excites a lot of interest in investors but there are dangers for those who get carried away by the marketing messaging that accompanies it.
What most commonly comes to mind when thinking of thematic investing are funds that specialise in areas of the market that have a strong investment story behind them and a common “theme”.
Water scarcity is a serious issue in the world and one that many fear will intensify as the global population grows. What presents a threat to life may also present an opportunity for investors
An illustration might be water. About two-thirds of the world’s surface is covered in water but 97% of it is saltwater, which we cannot drink and which cannot be used to water crops. It has limited industrial uses too.
Water scarcity is a serious issue in the world and one that many fear will intensify as the global population grows. What presents a threat to life may also present an opportunity for investors. There are a number of water funds that look to invest in companies working in this area.
These might include classic water and sewage companies like Severn Trent, but also firms developing desalination technology in emerging markets.
Other popular themes include automation, healthcare and biotechnology. These are all areas of the market that have already experienced exponential growth and are expected to enjoy more. There would seem to be some sense in finding specialist investment managers who can identify the companies most likely to succeed.
Proponents of this kind of thematic investing argue that in a globalised world, building portfolios around these themes is far more useful than building them around traditional investment models that allocate capital to countries or regions – 40% to the US, 20% to the UK, 15% to emerging markets, etc.
But there are challenges to building a portfolio purely around themes. The first is that it can be hard to find good enough companies to justify the creation of a whole fund around a topic (despite what the marketing teams might say). As a consequence, you end up with many stocks you might not necessarily hold in a global “best ideas” portfolio. These can be a drag on performance.
By its nature, thematic investing can also lead to investing in earlier-stage companies that are developing new technology. This can increase risk within a portfolio and you may have to show patience for them to bear fruit. We meet a lot of thematic managers and often see a mismatch between the potential of the fund and the actual performance. Too much focus on themes can also limit diversification and leave you with too many eggs in too few baskets.
ESG (Environmental, Social and Governance) orientated investing is a huge growth area, particularly with younger investors but certainly not exclusively so. We are able to connect users with wealth managers who specialise in responsible or even impact investing as their main focus, but equally we know which firms offer these kinds of overlays within a more traditional set-up too. If you are interested in ESG or impact investing, just indicate this when embarking upon our 3-minute search.
This does not mean you should not embrace thematic investing within your portfolio. A sceptical and pragmatic approach may help. Though sceptical of many specialist thematic funds, we have found some good managers in the technology and healthcare sector and have incorporated their funds as an element within client portfolios. We value their specialist knowledge and the diversification these managers can bring.
Elsewhere, we apply thematic thinking to all our investment analysis. A large proportion of any JH&P client portfolio will be in direct equities – stocks that our own investment managers have identified for their quality. This direct approach can help reduce costs and keeps portfolios focused.
Though sceptical of many specialist thematic funds, we have found some good managers in the technology and healthcare sector and have incorporated their funds as an element within client portfolios. We value their specialist knowledge and the diversification these managers can bring
In selecting stocks our managers look beyond the numbers to the investment story. They avoid companies facing headwinds and actively seek out those industries and areas that have opportunity for disruptive long-term growth (like automation, which reduces manufacturing costs, and biotechnology/healthcare, where new drugs and radical new approaches to treatment and diagnosis are being developed).
We can use these stocks to build diversified portfolios that constitute a selection of our best ideas, incorporating several promising themes. This is a more flexible and pragmatic approach.
A growing number of investors are requiring their portfolios to be run to an ethical or sustainable mandate. This is another way of thinking about thematic investing. In a sense it is an over-riding theme for the whole portfolio – a thematic overlay.
Sustainable investors look for companies that limit their impact on the environment, that contribute to society and that are well governed with a diverse management structure and transparent finances. (This approach often carries the acronym ESG – Environmental, Social and Governance.)
A growing number of investors are requiring their portfolios to be run to an ethical or sustainable mandate. This is another way of thinking about thematic investing. In a sense it is an over-riding theme for the whole portfolio – a thematic overlay
Ethical investing is similar, but companies can be excluded on moral grounds, which vary from client to client. Common exclusions are stocks engaged in tobacco, gambling, munitions, oil and pornography.
We apply sustainability criteria to any investment on the grounds that sustainable investments will be more successful in the long run. But we have the ability to overlay onto a client’s portfolio a distinctly tailored set of strict ethical and sustainability rules if required. We can apply these filters to the equities we buy directly and in choosing the specialist funds that complement the direct equity element of portfolios.
You do not need to have a portfolio built purely of thematic funds for thematic investing to be incorporated within your investment strategy. Talk to your wealth manager and you will probably find that themes like technology, healthcare and sustainability are already embedded within the investment process. If required, ask if you can have your personalised ethical thematic overlay applied to your portfolio.
There is a lot to be said for thematic investing, but not at the cost of traditional investment disciplines. We argue that it should only be part of your approach
There is a lot to be said for thematic investing, but not at the cost of traditional investment disciplines. We argue that it should only be part of your approach. The risk, otherwise, is that you end up investing for a good story and not for good returns.