Thematic Investing - In it for the Long Run

The pace of transformation in our world is unprecedented. Each new idea has the potential to present a stroke of genius and lead to disruptive change. While many of those ideas might end up floundering, there are those that drive the progress of a generation and flourish with it.

What we are concerned with here are far-reaching transformative changes that redefine how a society interacts with the world around them; shifts that give way to a whole new paradigm that can capture the spirit of a time.

These sorts of megatrends give rise to new economical structures and affect the flow of money in the markets. Investors identifying these megatrends stand at the source of unique and seismic growth potential.

This is what thematic investing is: early identification of big, cross-industry change with long-term effects over society.

Banking on tomorrow's winners

Thematic investing's search for new drivers of growth shifts the focus away from traditional sector and cyclical views. It also results in characteristics that differ vastly from the profile of the traditional stock-picking portfolio.

First of all, it means breaking away from past performance. Thematic investing is daring; it relies on a predictive assessment of future growth as opposed to history. To do so, investors must look at what lies ahead, rather than look back.

Secondly, investors are also changing their time horizon, placing bets on trends that far outpace the annual or even quarterly earnings calendar that has come to dominate equity markets.

Finally, thematic investing provides diversification from the sector allocation of market-capitalization weighted indices, which give more gravity to the winning industries of the recent past. If properly identified, such universe may help reduce a portfolio's risk and volatility.

Judged and tested by their resilience to 'fads'

In order to secure their long life span, investment themes must be rightly chosen to deliver beyond short-term trendiness.

A topic like ageing population is a good case in point. The United Nations1 has estimated that the ratio of people over 60 will rise to 20% of the global population by 2050, from 13% in 2015, even as high fertility rates in emerging nations boost the overall number. That's a three-decade long transformation.

Enduring themes with growth prospects now

This year, a study2 by consulting firm McKinsey looked at the performance of 615 US stocks from 2001 to 2015. Companies that focus on long-term patterns of investment, growth and earnings quality were found to outperform their short-term-focused peers on a range of key financial metrics. For example, the revenue of 'long-term' firms cumulatively grew on average 47% more than the revenue of other firms in the whole period, the authors found. In this sense, thematic investing comes to counterbalance the short-termism in markets.

Yet investors don't need to wait long to reap the benefits of megatrends. Revenue from unit sales of all types of robots, for example, has been forecast3 to jump to $237.3 billion by 2022, from $31 billion in 2016. Global online spending, part of the digitalization theme, may reach $4 trillion by 2020, up from $2 trillion in 2015. Overall retail sales, meanwhile, are likely to grow only 22%.4

The constellation of a thematic portfolio

Thematic indexing cuts across sectors, geographies and styles, and has a high degree of industry specificity. It is intended to achieve a targeted and precise exposure to a market segment. This cannot be done without the help of a granular analysis of exposure data on company and portfolio level. This is why at STOXX we partnered with FactSet and used their Revere data in our Thematic Indices.

The FactSet Revere industry hierarchy is the world's most comprehensive business classification, which looks with an astonishing level of detail at what companies do and who they sell to. This helps us screen with accurate visibility for those companies best positioned to benefit from each theme.

STOXX Thematic Indices

Our iSTOXX® FactSet Thematic indices family was launched in 2016 in collaboration with FactSet and BlackRock's iShares. The indices offer a systematic approach to track stocks influenced by four themes shaping the modern world: Ageing Population, Breakthrough Healthcare, Automation & Robotics and Digitalisation.

The themes are broad and deep, and have multi-decade possibilities, allowing for a stable, long-term strategy. The iSTOXX FactSet Thematic indices have, on average, outperformed the iSTOXX® Global 1800 Index every year since 2012 except for 2016.5

Investability and diversification

Using indices can overcome some of the difficulties associated with thematic investing, such as the investability of the theme or the cost of research of less-followed stocks. It also brings the benefit of inexpensive and diverse exposure to a theme, as well as diversification from the market.

Since September 2016, the iSTOXX FactSet Thematic Indices can be accessed through respective exchange-traded funds (ETFs) managed by iShares.

Investment themes that are properly selected following careful consideration and analysis should outlive business cycles and their swings. For investors with multi-year capabilities, structural themes offer an appealing and portfolio-transformative proposition.

Roberto Lazzarotto is Global Head of Sales, STOXX


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