Are you an investor or a speculator? Put another way, there are different styles of investment; some seek steady accumulation over time from collecting dividends, rents or interest, while others focus on seeking quick returns from price variations. Thematic investing, which focuses on broad, long-term trends, best suits the investor, rather than the speculator, and matches the longer-term time horizon of most institutions and the majority of private investors in equities.
Over the last decade, themes have appeared increasingly frequently in investment commentary – as soon as a trend materialises, it seems that someone wants to classify it as a theme and allocate stocks to it. Legalising cannabis, crypto currencies, space exploration or WFH are all novel trends but do they really fit with a long-term, thematic investment approach?
Themes need to be built in at the basic design phase of an equity strategy. Conventional design subdivides a portfolio by geography. But despite forensic expert analysis of macroeconomic variables in each country, there is little evidence that regional asset allocation adds much value. Indeed, most of the large listed companies today are multi-national and span several regions. Even if their customers are in one country, their supply chains and competitors may stretch around the world and across the internet. Trying to attribute national characteristics to predict companies’ performance often exposes a frustrating mis-match. On the other hand, allocating to a range of global themes can provide a structure to better plan portfolio strategy.
A longer-term investment horizon begs the question ‘how will the world change by 2030?’. No crystal ball is needed to predict that technology will continue its rapid development, or that the response to climate change and biodiversity loss will gather greater momentum, or that rising life expectancy will expand an ageing population. Such inexorable secular trends would seem to offer greater certainty on which to base the portfolio strategy.
The purpose of a theme is to identify investments that have a higher probability of achieving growth and good investment returns over time. Under the large headline trends lie many exciting sub-themes. But beware, some strong growth trends don’t make good investment themes. For example, for the last 15 years or so, we have seen rapid growth in the number of solar panel installations. Yet the Société Générale SOLEX Global Solar Energy Equities Index fell 80% in the ten years to the start of this year when the index was suspended. Manufacturing solar panels has been a cut-throat business and is now dominated by Chinese manufacturers with scale and state support advantages. Just spotting growth is no substitute for good detailed financial analysis.
A strong investment theme helps an analyst to consider the underlying business drivers that can make a company prosper over time. It helps differentiate the likely long-term winners from the losers. It helps establish conviction in the investment for the long term and overcome the psychological anchoring to shorter-term performance that prevents many investors from seeing the full potential in a long-term investment. A theme puts greater focus on specific corporate growth drivers rather than the macro or cyclical factors that affect a region.
Where do we see the strongest themes?
Yes, technology stocks have performed well, but for good reason: Digitalisation fundamentally alters the competitive landscape. Covid-19 has accelerated digital adoption and ‘dematerialisation’ and the benefits will accrue not just to the FAANGs, but to a fast-growing ecosystem of mid-sized companies that provide the essential tools to gain competitive advantage. Artificial intelligence is bringing natural language processing and machine learning so that machines can comprehend, see and learn. Automation will transform the relationship between people and technology, boosting our creativity, speed, precision and productivity. Medicine will also start to deliver amazing advances from the ability to process enormous quantities of data and fix single faulty genes.
Asking how the world will change by 2030 leads us to conclude that it will be technology and human ingenuity that seek to fix many of the large challenges we face, from climate change to biodiversity loss. These will need a social and cultural shift too, the early signs of which are underway in the new espousal of conservation: less, not ever more, consumption is the solution to many environmental challenges. Greater awareness of ESG is itself creating new themes.
Whilst economic growth in the developed world is badly affected by the pandemic, standards of living for billions of poorer people will continue to improve. Many will shift to a middle-class lifestyle over the 2020s. This is driving powerful underlying shifts in consumption, like diet change. And, as longevity improves everywhere, populations will see increasing proportions of elderly people – the population of over 65 year olds will double by 2050. Ageing drives many different consumption patterns and service needs, and offers a plethora of commercial growth prospects.
Themes work both ways – they also help identify investments to avoid. The share prices of many ‘blue-chips’, like Citigroup, Marks & Spencer or General Electric, are all lower today than 25 years ago. Studying the long-term disruptive forces affecting businesses can help steer away from industries struggling to generate sustainable growth. For the speculator they may offer short-term value but the outlook for many established business models will remain challenging – from oil companies to banks, high street retailers to car manufacturers, there are many casualties of change.
Looking past the pandemic, the trend of global economic growth in the decade ahead looks to be much slower. Demographic trends are playing a key role; since the end of the WW2, the world population has more than tripled in one lifetime. Quite simply, every year more people earning salaries and spending made activity in the economy expand. For investors, it was a strong tide that lifted all boats. But whilst lower-income regions including Africa, India and some other Asian countries will continue to add new workers, the developed world no longer has a growing workforce. Only the over-65 population is expanding.
A new normal of slower growth changes the investment choice from more or less growth to growth versus decline. Investors need an investment process that helps them differentiate. Constructing a portfolio based on broad, inexorable themes makes increasing sense for any investor planning for the decade ahead.