The case for thematic equity investing
What is thematic investing
Thematic investing is an investment approach that aims to deliver long-term value. It’s focused on economic, geopolitical, technological, environmental, and demographic themes or trends that we believe will drive growth in the future.
At Aberdeen Investments, we take a global and thematic approach to investing. This gives us a deeper understanding of why and where the world is changing. It also provides investors with access to these opportunities.
How does it work?
Thematics is an alternative way of investing compared with more traditional investments, such as bonds, equities or mutual funds. It can be integrated into almost any portfolio, and it can enhance returns in a risk-efficient way.
Thematic investing offers exposure to one or more themes in a diversified way. This approach enables investors to take an active yet balanced view on a trend.
Example
For example, an investor would like to invest in electric vehicles. This could be because they have an established conviction in the theme through their own research, or it could align with their personal views and values. They could, of course, invest in Tesla or Nio for exposure, but then they are exposed to a high degree of single-stock risk. While car manufacturers play a key role in this theme, so do miners of raw materials, battery manufacturers, and those developing the charging infrastructure. We aim to target the parts of the market that clearly represent the theme, and where we believe the most value is accruing.
Thematic equity investing is experiencing growth
The assets invested in global thematic equity funds have been growing at an organic compound annual growth rate (CAGR) of nearly 11% over the last three years. This compares with a CAGR of 1% in global equities, generally.
When asked about the biggest winners over the last two years, investors are likely to reference themes such as artificial intelligence (AI), rather than specific sectors, geographies, or styles. AI is a prominent theme, and exemplifies the substantial growth observed in the thematic investment category. This trend suggests that traditional investment frameworks, which focus solely on sectors or geographies, may not adequately capture the growth potential in our highly globalised and emerging world.
It can empower investors
Thematic investing can empower investors by enabling them to make informed decisions and take control of their portfolios. Millennials and Generation Z are emerging as key market participants; they are looking for investment opportunities that offer greater control. Additionally, thematic investments can align with their values and perspectives, allowing them to observe trends unfolding in real time.
Forward-looking approach
Picking the right funds to invest in can be a backward-looking exercise, always remembering that past performance is not a reliable guide to the future. Potential investors consider whether a fund has outperformed its benchmark and how volatile the performance has been. While these are still important considerations, thematics offer investors the opportunity to gain exposure to areas where they believe long-term trends will drive future growth. Thematic funds offer a way to gain exposure to a theme in a pure and holistic way, while still balancing risks.
Thematics are differentiated
Thematic investing is agnostic to, and unconstrained by, sector, geography and market capitalisation, so it should transcend traditional business cycles.
Thematic equities can also help to diversify sources of risk and return. They can offer good sector diversification, especially when combining different themes. A balanced selection of themes, with differentiated outcomes, can help to drive superior risk-adjusted returns at a portfolio level.
Thematics are outperforming
Thematics, like sectors or geographies, will still have winners and losers. But if we examine the mean of thematic indices, they have still outperformed global equities over the past five years.
MSCI ACWI IMI vs Mean of MSCI ACWI IMI Thematic Indexes Q1 2020 - Q4 2024
Thematics have outperformed for three key reasons:
- Long-term trendsOver the long term, the ultimate arbiter of returns is earnings. Fluctuations happen over shorter periods but being on the right side of growth is the most important driver of success. Companies aligned to growth themes are most likely to outperform.
- Growth alignmentThematic investments often have a growth bias. This means they’re designed to capture future growth opportunities, by investing in sectors or companies that are expected to grow significantly. We believe thematics perform well as a group because they focus on ‘disruptors’–companies or technologies that are changing industries – rather than those being disrupted. This can lead to outperformance compared with more traditional investments.
- Focused strategyCompanies that benefit from long-term trends typically have a much clearer view of their strategic priorities. They concentrate spending on areas that promise the strongest growth.
Ways to invest
- Single-stock allocationIt’s possible to allocate to a small number of individual stocks to gain exposure to a theme. But not only does this increase the level of single-stock risk an investor is exposed to, but it could also overlook related companies.
- Index selectionThere are thematic indices and passive thematic funds that give broad exposure to a theme. However, they tend to be slow to react to change. They are also more backward-looking in nature, given they rely on data for their stock selection and most available data points are backward-looking.
- Active thematicsWe research a theme and the companies most aligned to that theme. We then take an active view on the best way to capture risk-adjusted returns in a diversified way. Data can be helpful in assessing the importance of a stock to a theme, but there are some links and correlations that can’t be uncovered with data alone. This is why taking a forward-looking active view is helpful in thematic investing. It broadens the range of opportunities, and results in more aligned and more relevant thematic portfolios.