Market thinking

From niche to norm: why investors should consider thematics in their portfolios

The spotlight on popular themes offering a route to more reliable investment returns seems to be sharper than ever before.

As various economic, political or societal structural shifts become embedded in the world around us, investors are increasingly looking to build a portfolio around companies that are well-placed to benefit from these trends – rather than a sector or geographic region.

Sustainability is probably the most obvious and notable example of this focus on thematics.

Recent evidence of this is a report released in mid-July 2021 by the Global Sustainable Investment Alliance. It shows that sustainable investments total US$35.3 trillion – or more than a third of all assets in five of the world's biggest markets1. This was a rise of 15% in total assets across the US, Europe, Australasia, Japan and Canada since the previous report from this biennial industry survey.

Among the key factors fuelling this growth are rising consumer expectations, strong financial performance and the increasing materiality of social and environmental issues. Further, the view that thematic strategies can help investors future-proof their portfolios is ever-more compelling.

For individual investors, however, they need to ensure their thematic portfolios are built and managed using a well-considered process that reflects not only current trends, but is also able to adapt to future ones.

New thematic way of thinking

This is a relatively new challenge. To address it, investors must be familiar with how a theme is segmented.

Yet with trends as diverse as millennials, robotics, clean energy and the circular economy, for instance, the thematic landscape might be perceived as too diverse or complex to access in a clear or coherent way.

Making the situation more difficult is the lack of a universally accepted categorisation. The result is sometimes confusing.

A starting point is to understand that the value of thematic investing might typically be derived from its focused, specialised, flexible and high conviction style.

As a result, Broadridge, a global fintech leader, suggests investors think of thematic strategies in five broad groups: sustainability, emerging technology, changing consumption, healthy living and multi-theme – with sub-sectors to underpin each of them.

In applying this, research by Broadridge2 highlights clear trends among investors in Asia Pacific:

  • Emerging tech is the largest macro theme in terms of flows, followed by sustainability
  • Other’ technology and disruptive tech funds show highest cumulative flows among the micro themes
  • By geography, China is the largest market by flow and volume of thematic funds, due to a significant rise in such activity since 2019

Better active than passive

For investors to incorporate specific themes in their portfolios, these investments don’t typically form a core element. Instead, thematic funds often form part of a global, strategic approach to portfolio construction via a smaller – or satellite – role.

The funds are often a diversifier, to balance traditional approaches. While they are part of long-term and strategic trends, since many themes are evolving, they require investors to be watchful of them in the short term.

This also requires fund managers be nimble enough to capture inflection points and shifting patterns of growth.

The Broadridge research, for example, said that nearly three-quarters (73%) of thematic assets the firm tracks are held in active as opposed to passive funds3.

At the same time, the presence of more institutional investors in this market offers additional evidence that the trend towards a thematic approach is part of a fundamental and carefully thought-through process for all types of investors. The same Broadridge research shows that the proportion of thematic fund assets under management held by institutional investors in European cross-border funds jumped 9.8% between the first quarter of 2017 and the final quarter of 2020.

Selecting the right theme

Inevitably, it is necessary to apply additional checks and balances within selection processes when assessing thematics.

It is essential for investors to have a clear idea of how the theme reflects the qualities they value, along with the potential pitfalls of the theme.

In addition, investors need be assured that the target fund properly represents its thematic goal – and aims to achieve it with a concentrated and focused portfolio. For example, a thematic fund in most cases should contain fewer investments than a traditional equity fund.

Moreover, investors should expect a thematic fund to be adaptable and flexibly managed to reflect changes in the market.

Transparency is another key feature that investors should focus on. This can be achieved by opting for a theme that is clear in a fund’s title and consistent in the underlying holdings.

Thematic investing: from niche to norm

As investors address these issues, the growing weight of funds flowing into ever-popular themes appears to be an irreversible trend that will influence the future development of the asset management industry.

The momentum is already strong; from 2017 to 2020, this corner of the industry had increased to represent 39% of all equity fund net sales.

This dynamic looks set to continue as investors get increasing comfort with how and where thematic strategies fit within their overall asset allocation. And with an ability to offer investors the potential for superior long-term investment returns, thematic investing will drive a fundamental shift for portfolios over the coming years.

Sources:

[1] http://www.gsi-alliance.org/wp-content/uploads/2021/07/GSIR-2020.pdf

[2] Research was based on interviews with 90 fund selectors in Europe, Asia Pacific and North America during Q1 2021, exploring their usage of and views on thematic funds on a qualitative basis

[3] AXA IM and Broadridge research, “Thematic investing set to transform asset management?”