This is the first in a series of notes on Thematic Investing that we will be issuing in the coming months. The purpose of this note is to set the scene.
Thematic investing is an approach which focuses on investing into long-term trends rather than specific sectors or regions. A thematic approach differs from traditional portfolio construction in that it is typically unconstrained. It can move away from the grid-like method of asset allocation or being limited by a benchmark. By definition, Thematic Investing avoids the confines of geographical boundaries, style biases and market capitalisations, in its search for new drivers of growth. In particular, it cuts across traditional sector classifications of equities.
The topic of Thematic Investing has gained traction since COVID-19 rattled financial markets over a year ago, and the following Themes have gained in stature as investors have reassessed their long-term outlook during the pandemic:
- Environmental, Social and Governance (ESG)
- Disruptive Technology (e.g. Artificial Intelligence, Blockchain, Machine Learning)
- Healthcare
- Infrastructure
ESG is a powerful demonstration of the rise of investor interest in Thematic Investing. COVID-19 has made us feel more vulnerable and perhaps more aware of our place within the natural world and has, consequently, accelerated a number of forces that were at work in the global economy prior to February 2020.
The economic recovery from the global pandemic is being couched as Build Back Better, a term first coined by the World Economic Forum back in April 2020, and this has driven a huge amount of investment into the ESG and “Sustainable” space during the last twelve months.
ESG and Sustainability are now part of the investment industry vernacular and cannot be ignored. Large institutional investors such as sovereign wealth funds and pension funds have been notable participants and leaders in this field. A good example is the Norwegian sovereign wealth fund, valued at around $1.1trn, which is divesting itself of underlying fossil fuel investments.
Quartet’s approach to Thematic Investing
The investment process at Quartet is driven by rigorous research into macroeconomics and long-term investment opportunities. We look at the big picture, and this is where Themes are identified.
We began to question the ongoing efficacy of Quantitative Easing in 2017, so began to move away from passive, index-based, geographic allocations. Instead, we adopted a more considered approach to portfolio management by increasing our focus on the identification of investable, long-term Themes that we felt would add value to clients’ portfolios over time. During the pandemic, our thinking and portfolio construction have evolved further.
The growing appetite for Thematic Investing comes from the need to identify future drivers of growth (such as technological breakthroughs), which gives equity investments the potential to outperform traditional broad indexes which reflect the movement of the entire market. That said, the embracing of Themes by a broader section of the investing community has, in our view, tended to focus on a very narrow area. Many opportunities outside the scope of what is currently being considered under the new Growth theme have, in our view, very attractive properties.
Identifying the potential for structural change and investing in expected transformations early (such as the rise of the internet in the 90s) is, in our opinion, a key driver of successful investing. This is particularly important for long-term investors to ensure that their portfolios are positioned for growth opportunities whilst avoiding the casualties.
Thematic Investing has been part of our investment process for many years. Quartet is perhaps different in that Investment Themes have not been a direct focus themselves but have rather been the output from our approach which focuses on core, structural and MEGATRENDS which we identified a number of years ago, and which we update regularly from our research.
The beauty of MEGATRENDS is their inherent resilience since they tend to be long-term and structural in nature so are less vulnerable to short-term cyclicality and market shocks. Essentially, we are trying to invest in Thematic areas where we have a tailwind at our backs. However, it is as important to be aware of what may lose as a result of a new MEGATREND and if it is not possible to participate in the downside, to at least make sure the negative impact is limited.
The following are the key MEGATRENDS that we, at Quartet, are currently focused on:
- Late stages of the debt super cycle
- Changing demographics
- The rising wealth disparity between rich and poor
- Rise of the East
- The era of disruption / disruptive technologies
- Climate change drivers
The following chart offers some insight into our current thinking regarding themes that have been derived from these MEGATENDS.
Source: Quartet Investment Managers
Timing
Timing is crucial 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 so as to avoid dormant capital. On occasion, it is possible to take advantage of broad market volatility to enter into to a theme at a depressed valuation, much as we did when we invested into the Cloud Computing/Remote Working theme in April of last year. However, history tells us that opportunities created by extraneous global events tend to only occur once a decade at best and so waiting for these is a poor substitute for having identified the right themes to begin with.
In the remainder of this series of notes on Thematic Investing we will explore the process of theme identification in greater detail and how Quartet has determined the stage at which each theme is currently positioned. This then determines the attractiveness of each theme as an investment opportunity and we will review these in individual thematic notes.
Quartet Investment managers, June 2021