Thematic Investing: Transcending the traditional
In such a transformational world, is it time to broaden our investment horizons away from the traditional asset class, geographic and sector orientated framework? Incorporating a thematic element to strategic asset allocation could provide an effective way to harness some of the mega trends that are currently reforming economies, society and, importantly, driving financial markets.
The basic investment premise of seeking out the winners and avoiding the losers has meant that thematic investing has tended to be associated with equity investments. But this doesn’t have to be the case. There are now a number of fixed income and even multi-asset thematic funds, underlining the notion that thematic investing can transcend the traditional classifications of asset class, sectors, regions and styles.
Ultimately, anything that can give a group of companies an advantage over their peers in a particular industry can be used to pursue an investment theme. However, the factors playing an important role in changing the balance of forces typically stem from the megatrends that are reshaping society. Be that globalisation, digitisation or regulatory trends.
What is important when looking for companies exposed to a theme is that the selected companies have a significant part of their business dedicated to activities related to the theme and generate a significant part of their revenues from selling products or services related to that theme.
Other themes that have been strong in the past may be nearing the point of maturity – previously robust twentieth century activities are being replaced by innovative twenty-first century technologies – so it’s important to try and gauge when an investment theme has run its course even if the overarching drivers remain relevant and investable. The transportation sector is a clear example of such a transition as combustion engine vehicles are replaced by electric ones and the whole notion of transport as a service could transform how we use cars in the near future.
Applying a bottom-up investment strategy can be advantageous for thematic investors as it can be more subtle than just finding undervalued opportunities to hold over long investment horizons.
Not all ESG investing is necessarily thematic investing. There is a difference between investing in companies just pursuing sustainable practices and companies deriving a significant component of their revenues from services and products related to sustainable themes. However, the desire to drive change in society has proven to be a strong motive for thematic investing in recent years.
The energy transition is a good example of this type of thematic investment. Climate change is perhaps the biggest challenge humanity has ever faced and is already having a profound impact on weather systems and economic outcomes. There are necessary steps that must be taken to address climate change and this will inevitably create investment opportunities.
Investing around a sustainably-orientated theme means finding companies well positioned to generate a measurable impact while profiting from this structural change.
Focusing on a specific theme will lead to higher concentration levels in the specified area, resulting in less diversification and raising the potential for more short-term volatility during times when that theme goes out of favour. However, a benefit of thematic investing is that it tends to avoid companies that are on the receiving end of disruption or decline.
Ensuring a thematic portfolio has an adequate risk management framework is critical to ensuring it is capable of handling the different risk exposures of the assets and themes, while also taking into account their expected returns, as well as the level of risk aversion of the end investor.
But where there are winners, there will also be losers, those exposed companies that are either unwilling or unable to adapt will be left behind. And the ability to distinguish between them will be critical for any investment strategy to truly succeed.
At BNP Paribas Asset Management, our forward-looking thematic investment strategies are positioned to capitalise on the megatrends shaping the future. Our investigative mindset and determination to consider all angles presents us with a strong understanding of these new ecosystems and upcoming business models. Covering a range of trends that includes the energy transition, environmental sustainability, equality and inclusive growth, health and wellness, as well as technology, we aim to provide sustainable thematic investment solutions for a changing world.
For further insights please read our white paper: Allocating to Thematic Investments