In a world of low interest rates, volatile investment markets, and rapid change, many investors have begun to question traditional approaches to investment management.
Traditional forms of investment management, which utilise benchmarks, can be rather inflexible and also quite backward-looking, and as a result, can lead investors in the wrong direction at times.
For this reason, many investors are turning to more flexible ‘thematic’ investing strategies, which are forward-looking in nature and aim to profit from dominant long-term trends across the world.
So, what exactly is thematic investing and what are its benefits?
Broadly speaking, thematic investing is an investment strategy that aims to identify, and profit from long-term structural trends that are shaping the world.
The world in which we live is dynamic and constantly changing, and thematic investing is designed to capitalise on these changes, and generate powerful investment returns from long-term growth stories.
Focusing less on benchmarks and more on big-picture ideas, the strategy offers a unique approach to investment management.
Traditional benchmark approaches to investing are based around the process of either adhering to, or deviating from a benchmark in order to enhance returns or limit downside risk.
While this approach has been widely accepted within the investment management industry the problem with this style of portfolio management is that it tends to be quite rigid in nature.
By definition, this style of investing also tends to assume that past winners will continue to win out, as the largest weightings within key equity index benchmarks across the world are large-scale companies that have enjoyed success in the past.
In contrast, thematic investing offers a more flexible approach to investment management. The strategy is more forward-looking as it seeks to anticipate new trends, embrace change and take advantage of future growth opportunities.
The Thematic Investing Process
The beauty of thematic investing is that, at its core, it’s quite a simple approach to investment management.
The first step in the thematic investing process involves identifying long-term ‘secular’ trends and translating these into investment themes.
For example, one such trend that we often hear about is the ageing population across the world. Over the last half century, life expectancy at birth has increased by almost 20 years, and the number of elderly people across the world has increased significantly. Another dominant trend is the increase in wealth across the world’s emerging markets.
As a whole, emerging markets are growing at around twice the pace of the world’s developed countries and in the coming decades, we are going to see millions of people across these regions enter the world’s middle class.
Once a number of powerful themes have been identified, the next steps in the thematic investing process are simply identifying and analysing companies that look set to benefit from these themes, and then constructing a portfolio.
By understanding the investment opportunities associated with dominant global themes, investors can increase their chances of generating above-average returns over the long term.
The Advantages Of Thematic Investing
Thematic investing is a strategy that has many benefits. Here is a look at four key advantages.
Capital growth: Naturally, as a strategy that aims to profit from the success stories of tomorrow, thematic investing offers investors the potential for long-term capital growth. When executed properly, investors can profit from disruptive technology, changing consumer behaviour patterns and long-term demographic shifts.
Intuitive approach: Thematic investing is also a strategy that is very easy to understand. It enables investors to put their money into areas that interest them and this can make investing considerably more relatable.
Long-term focus: The long-term nature of thematic investing is also beneficial as it can help investors ignore short-term market movements and stick to their investment strategies.
Diversification: Moreover, thematic investing can offer diversification benefits. That’s because often, thematic portfolios have low correlations to traditional equity portfolios and benchmark indexes such as the FTSE All-Share index or the S&P 500 index. As a result, thematic portfolios can help hedge other portfolio risks and reduce overall portfolio risk.
The Risks Of Thematic Investing
Of course, like any investment strategy, thematic investing is not perfect and does have its drawbacks. For example, investors need to be aware that thematic investing is a long-term strategy that can take time to play out. It requires patience and discipline and is therefore unlikely to suit those with shorter-term investment time horizons.
It’s also worth noting that thematic investment portfolios can under perform global equity indices at times. As such, the strategy may not be suitable for those who are unable to tolerate deviations from mainstream equity benchmarks.
However, overall, thematic investing is a strategy that can suit a variety of investors and offer a number of benefits. A forward-looking approach that embraces change and focuses on big-picture ideas, it is highly suited to today’s rapidly-changing world and complex financial markets.
What To Read Next
Find out more from our complete guide to thematic investing which takes a closer look at the benefits of thematic investing and highlights 10 key themes we believe offer compelling long-term investment potential.
This does not constitute advice