Thematic Investing – Process

This is a follow on note to one we published earlier in the year where we “Set the Scene” around Thematic Investing and how we approach it.

The process of Thematic Investment continues to draw upon the same principles that have been in place for investors for decades.  Firstly, a sound economic basis for the investment idea is required.  Thinking about economic research has evolved over time with different approaches rising to prominence at different periods.  As changes in economic research occur so too should the investment portfolio evolve.

Niels Jensen, our CIO, and his team provide the Macro Economic research for Quartet and through this drive our idea generation. “Thematic” investing is our recognition of core, structural, “megatrends” that have been identified by Niels.  The beauty of “megatrends” is their inherent resilience, tending to be long-term and structural in nature, so are less vulnerable to short-term cyclicality and market shocks. The image below displays the six megatrends that form the context for our Thematic investment strategy.


Source: Quartet Investment Managers

Our responsibility is to generate attractive, risk-adjusted, returns for clients, so the initial move was to introduce an allocation within portfolios to Thematic Investments.  The allocation began at 5% and grew over time to around 15% of client portfolios as new Themes were identified and added.  As it has become increasingly obvious that we have more Thematic ideas than we can accommodate in portfolios and also that cycles continue to influence the returns and popularity of different themes, we have recognised that further evolution is required to increasingly diversify portfolios by Themes.

We published the following chart in our previous note introducing Thematic Investing.  Its application is crucial for our construction of Thematic Portfolios and so it appears once more.  Timing is important in thematic investing, and we aim to invest at a relatively early stage where the theme is not yet fully recognised (but not too early to avoid dormant capital).  The stage of development of Themes on the ‘S’ curve of growth relative to each other is being continually assessed, and adjusted when appropriate.  We want to position portfolios primarily in the themes located to the bottom left of the ‘S’ curve, which are highlighted in purple in the chart below.

Alternatively, during periods of market distress, we can take advantage of broad market volatility to enter into a theme toward the upper right of the chart at a depressed valuation, much like we did with the Cloud Computing ETF purchase in the first quarter of 2020.

Source: Quartet Investment Managers


Having identified the themes attention then turns to the asset class, investment vehicle and position sizing.  The allocation across asset classes has historically been a challenge for investors in Thematic portfolios due to investible products having only been available within a few asset classes for many themes.  However, in the last couple of years, evolution of the product landscape has introduced to market more product opportunities in a wider range of asset classes.  A good example of this is ‘The Race to 2o’ where only Equities were historically represented.   Corporate issuance of Green Bonds and more recently Government issuance has allowed Fixed Income funds and Exchange Traded Funds (ETF) to be developed focussing on Green Bonds.  In the Alternatives area Hedge Funds have started to employ strategies to isolate the performance of the Theme from that of the general market and Investment Trusts focussed on infrastructure specific to the generation or distribution of Renewable Power have been successfully launched.

Themes can be invested across asset classes or within a single asset class with the flexibility offering even more prospects for maximisation of return from a Theme.  Take ‘Electrification of Everything’ the process of building out the required infrastructure, essentially a redesign and build of the 1940’s grid system, plus the development and manufacture of batteries is natural resource intensive and requiring new technologies.  Holding Commodities and exposure to the companies at the forefront of the new technologies in Equity is the current positioning.  This is sure to change as we move through the different stages of this Theme.

The process of investment selection subsequently utilises the skill set and process developed at Quartet over the life of the firm.  With our whole of market approach and strong relationships with product providers we are able to continue to evaluate and identify the best in class investments.  In line with the founding principles of the business, ETF products are first considered as the cheapest way of gaining exposure to a theme.  These products have seen some of the most rapid evolution in the Thematic arena.  An underlying benchmark is required for the ETF to track and it is this that requires the most analytical attention.  Many ETF houses are now partnering with specialist firms to establish a benchmark for the ETF to track.  Their independence, benchmark construction, process of rebalancing, criteria for inclusion and many more factors all need to be considered to determine how investable the ETF that tracks the benchmark is.

Active managers have been in the Thematic world for far longer and have built up, in some cases, decades of track record.  However as we all know, past performance is not necessarily indicative of future returns, and this is where our expertise of manager selection comes into play.  Yes, historic performance is one factor to consider and this sits alongside a deeper analysis of each fund managers strategy, process and outlook.  Cost is also a big consideration.  Although many fund houses in recent years have recognised that they need to compete with the cheaper ETF product on cost, some product providers try to implement premium pricing for what might be seen as a more niche product.  This is where relationships really matter, allowing our clients to gain access to cheaper share classes intended for institutional investors rather than the Private or Retail Client.

In position sizing correlation of returns remains core to the process but of increased importance is consideration of the location of a Theme on the ‘S’ curve.  Where Themes are just starting to gain traction, the bottom left of the ‘S’ Curve chart, the exposure of a portfolio needs to be meaningful enough that the investment is going to make a difference to performance.  As the theme moves further up the ‘S’ then an increased allocation is warranted.  This may be through the addition of another position in the same Theme or increasing the size of a position.  The final stage comes as Themes move toward the top right of the ‘S’ and profit taking, position reduction and outright sales are options.

Throughout, a consideration of opportunity cost and shorter term cycles always play a part.  Currently we are wary of the popularity and the huge wave of capital that has been committed to “ESG” in particular.  We do not feel coerced by the moral imperative of responsible investing, rather appreciate it is becoming a condition of capital allocations as governments and regulators set it into law.  A number of our Themes cross over with ESG, which in short-term has seen an overvaluation of some asset classes where this wall of money has been directed.  This provides the opportunity to take profits and allows for reallocation of capital to areas where we believe there is presently a greater opportunity.

We continue to monitor opportunities to expand our thematic investing allocation across the asset classes.  This series of notes will continue with an introduction to each Theme individually.

Quartet Investment Managers, November 2021