Thematic Investing on the Rise

Published on 17 May, 2022

Disruptive technology is constantly reshaping the world. Despite the pandemic-induced lockdown, seamless internet connectivity enabled access to a virtual world where we could work, shop, and even meet people. Due to mobility restriction, labor shortage, and supply chain disruption, manufacturers have turned to robotics. Breakthrough treatments and medical advances in healthcare have helped combat the pandemic crisis. Climate change has shed light on vehicle electrification and the shift to renewable energy. Consequently, technological advancements such as AI, machine learning, blockchain, robotics, and data analytics are gaining popularity. The benefits of these disruptions, or rather “trends” and “themes,” are manifold. These trends are increasingly changing the way investors manage their portfolios.

What is Thematic Investing?

Thematic investing focuses on long-term structural trends and ideas to capitalize on them, rather than focusing on specific sectors and/or companies. It enables investors to get returns through potential opportunities created by economic, social, and technological changes. A theme-based investment approach allows investors to “personalize” their portfolios to include investments that are aligned with their interests or expectations and are geared toward select trends.

Thematic investing differs from other approaches of investing such as market capitalization, geography, style, value, momentum, and/or sector. In the past, investors had approached thematic investing through stocks, but thematic investing can include other asset classes as well such as bonds or real assets.

The goal of thematic investing is to identify investment opportunities that would give high returns due to structural changes in the underlying well-defined theme.

Source: Aranca Analysis

Global Landscape

Thematic investing has been gaining traction and popularity, leading to the emergence of many new thematic strategies in recent years.

Morningstar reported there were a total of 1,349 thematic funds by the end of March 2021. Over the past three years, AUM of these funds more than tripled from USD174 billion to USD596 billion worldwide. This amounts to 2.1% of total assets invested in equity funds globally, up from 0.6% over the last decade.

As these funds attracted more money, the scope of thematic funds broadened. A record 237 new thematic funds were launched worldwide 2020, up from 167 in 2019.

Source: Morningstar, Aranca Analysis

The growth of thematic funds has been uneven across the world. Europe is the largest market for thematic funds and its share in the global thematic fund market has grown to 51% from 10% in 2001. The market itself has grown twenty-eight times in size. While all the regions have witnessed net inflows, the US and Europe have been the prime beneficiaries of this growth saga.

One factor usually cited for driving the rise of thematic investing is that fund managers, at the request of a specific investor research, develop, and create a pool of investments that exhibit a particular theme.

Five Types of Thematic Investing

Thematic investing has various categories and approaches, which differ in terms of investor expectations and the ideology that determine the underlying investments.

Thematic funds (including mutual funds and ETFs) that are universally available to investors via various approaches are:

Source: Fidelity, Aranca Analysis

  1. Disruption: Investors who follow trends and the expected shifts or disruptions are likely to benefit from opportunities that arise when the market tends to underestimate the pace of change. Technology can cause rapid shifts in business models, and if market participants are not ready for it, it can cause a massive shift. A fund with an investing strategy centered on disruption is likely to focus on long-term structural trends, where industries and/or companies could be in the preliminary stages of development and working at driving a long-term change. For instance:

  2. Source: Aranca Analysis

  3. Megatrends: Megatrends are characterized by identifying trends that could lead to significant changes and transformations over the course of decades. Examples of megatrends include demographic shifts, long-term structural trends expected to transform global economies, technological advancements and innovations, regulatory and/or political changes, social and/or behavioral changes, and environmental developments. Megatrend funds focus on understanding the increasingly important drivers of long-term growth in earnings and returns.

  4. Source: Aranca Analysis

  5. ESG: Environmental, social, and governance (ESG) are the three crucial factors that an investor or a fund manager might consider before deciding to invest in a company. ESG focuses on how the company’s environmental, social, and governance practices impact society both positively and negatively. Many investors may be interested in gaining exposure to trends of sustainable business and sound corporate governance practices as well as social and human capital factors. Thematic investing in ESG is likely to provide the means to invest in an underlying theme that reflects a careful evaluation of these considerations.

    There are various ways to be an investor in the ESG domain, each with a specific approach to investment selection.

  6. Source: Fidelity, Aranca Analysis

  7. Differentiated Insights: Some thematic investing strategies are built around differentiated insights that usually do not fall under the categories mentioned above. These are also different from other approaches such as investing by market capitalization, geography, style, value, momentum, and/or sector. A differentiated insight fund helps an investor get exposure to targeted ideas and investment selections. They can choose to invest in companies that share the same characteristics, which may prove advantageous over the long term. For instance: 
    • Investing in companies that are still led by their founders
    • Investing in stocks of companies that use higher-than-average levels of leverage
  8. Outcome Oriented: In outcome-oriented thematic investing, the investment strategies that have been designed to pursue a particular set of outcomes in a portfolio. For instance, an investor who wants to largely remain invested in US stocks but is worried about inflation over time and its impact on their portfolio can choose to invest in an outcome-oriented thematic fund. This would also provide them exposure to companies and market segments that have historically performed well amid rising inflation.

    Similarly, funds that are designed to provide lower volatility of returns or minimize the impact of market downside choose to invest in stocks that have been less volatile historically and/or have performed better during times of market downturns.

    Investors following an outcome-oriented strategy would benefit from this type of thematic investing by seeking an outcome over a long term than by receiving short-term returns from that strategy.

Breaking Down a Theme – Theme and Sub-theme

Source: MSCI, Aranca Analysis

Source:  Aranca Analysis

As global economies adapt to highly impactful structural changes, investors have been willing to change course and accordingly adapting their portfolios and investments to capture the potential upside associated with these opportunities and disruptions. After all, thematic investing is about investing with a purpose.