Thematic Investing, Eyeing the Future and Capitalizing on the Trends

Thematic investing focuses on investing in the companies that may benefit from future trends. 

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What is Thematic Investing?

Thematic investing is a strategy that requires a fundamental understanding of the impact of long-term social, political and economic trends on regions and sectors, which reveal investable opportunities. Thematic investors are often keen to look out for second and third-order effects of the structural trends. These trends often create hotspots in specific sectors and regions where most of the value and risk will be concentrated.

An investor has three key benefits for implementing a thematic approach to investing. First, it allows investors to generate Alpha (return on investment). Second, the more systematic investment approach and In-depth analysis required for thematic investing build a deeper understanding of underlying value drivers and risk associated with them. Investors can use this knowledge in thematic investing and other investing strategies to further increase their Alpha. Third, it provides investors with dynamic and flexible ways to validate their hunches by applying a forward-looking lens to their investment decisions. 

Starting the Journey — 

A step into thematic investing doesn’t mean an investor has to completely overhaul their investing approach and portfolio holdings. But it still requires extensive research capabilities and a disciplined investment process. A five-step process achieves both objectives mentioned above and is used by many leading thematic investors. 

The first step to thematic investing is to have an open mind to all the trends, have a broad internal curiosity to make sure all relevant trends are considered and reach an agreement that’ll ultimately select some for more research. There are a number of factors to consider when prioritizing the trends, and the first is the trend structural or conjectural or short-term in nature? Does it pose material complications for the sector or the region? And second, does the company or the institution have the capability to generate specific insight into the trend and identify sufficient investment opportunities? Third, is your team, or are you excited about the trend and willing to invest the time looking into it?

At this stage, the investor should develop an in-depth understanding of explicit and implicit exposure to the selected trend before introducing more long-term risk into the portfolio. For example, suppose an investor is planning to invest their money only into Australia. The future aspect seems more stable for Aussie stocks and invests in an iron ore mining company. In that case, they must consider the company’s major customers. If the company’s primary customer is china, a slowdown in the Chinese economy or the tensions between political views can spell disaster for your investment. In a nutshell, investors must ensure that they understand true exposure — direct or indirect to these trends before they conduct additional analyses. 

Once key trends are identified, investors must trace them back to the theme they produce, often the implications for the sector or region. While increased food consumption in the emerging market is a strong trend, changing demand for dairy protein in china is a theme that can be researched for potential investment opportunities. 

The recent change in global weather and global warming and increased awareness of global warming in recent years is a strong trend. The theme one can research is slowing down the use of fossil fuels, increased research into wind and solar energy, and potentially finding some investment opportunities. 

Most attractive opportunities are found when multiple themes converge and reinforce one another in the various sectors. Identifying the relevant themes depends on the investor’s ability to uncover patterns and trends in revenue and profit pools. Making sense of the vast amount of information and economic trends is notoriously difficult. Investors who move rapidly from trends to themes before identifying specific investment opportunities often move faster and get more from their research investment and develop more detailed insights into thematic opportunities. 

3. Selection Of Themes — 

Investors and institutions typically agree on the simple based on their risk over return profile to succeed at this critical stage. This process can be simplified by asking a few questions about the investability and theme’s market prospect for the future. 

  1. Is the theme investable?
  2. Are there ways to deploy capital against it?
  3. Are there companies whose businesses are heavily exposed to the theme?
  4. Can the potential investment be made without running excessive risk?
  5. Are there other assets that might do well if the theme gains popularity?
  6. What is the risk if the theme doesn’t gain momentum?
  7. Do the companies within the theme have the capability to differentiate themselves? (Market access, thorough understanding of the asset, their value chains, relationship with suppliers and other vendors, privileged access to the right partners etc.)
  8. Does the theme fit within the current portfolio construction?

Prioritizing the theme is even more difficult as investors must make decisions based on improper knowledge. This process can be time-consuming and frustrating without the right approach but rapid and effective if appropriately designed. 

4. Developing an Investment Thesis — 

Once a priority theme has been identified, investors must develop an investment thesis around the theme. The thesis should clearly describe why and how value could be created over the long term. To form their hypothesis, investors can ask and research a few questions.

  1. What are the primary performance drivers in the industry?
  2. How do current value chains serve the key players in the theme?
  3. What are the current industry dynamics?
  4. How will the theme alter the industry dynamics, and can the current key players adapt to the changing market conditions?

To be successful at this stage, investors must first ensure that their thesis is based on the current facts, market outlook and free from biases. They must find opportunities in the business systems beyond those directly affected by the theme. For example, an investor looking into the impact on the increasing migrant population may determine that the best opportunity will be to invest in the suburb building projects and companies rather than real estate itself. 

5. Build a portfolio — 

Investors can then initiate the screening process across asset classes with a clear thesis in mind to find the best ways to take up a position in the theme. Most of the successful thematic investors at this stage have;

  1. A clear perspective on all the factors that’ll potentially lead to a successful investment within the desired time frame. 
  2. A list of potential targets that is systematically assessed against the success factors and monitored over time to find the right entry and exit points. 
  3. A clear investing approach
  4. A selection of investments that have both exposures to the theme and strong fundamentals to offset the long term nature of the investment. And the risk if the theme doesn’t materialize within your expected time horizon. 

To conclude, Thematic investing provides investors with an alternative to traditional investments. It leverages the greatest strengths of investors while providing opportunities to develop an in-depth understanding and informed opinions. By understanding the true exposure to a sector and then determining where and how to invest, increases their chances of getting superior returns over time. 

Credit: Mckinsey.com

Check out more: The Jolly Investor



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