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Why Is Thematic Investing So Powerful?

By Louis H-P on June 8, 2020

Reading Time: 4 minutes

Thematic investing is powerful because your are following a theme which is being supported by many others. This theme is usually a megatrend which is seen as disruptive.  When this theme comes good, it will change the economic landscape. Investors flock to these schemes due to the high growth prospects they can deliver. Like all investments, there is some downside risk!

Key Takeaways

Understand thematic investing

Opportunities it presents

Risks you should be aware of


How does thematic investing work?

Thematic investing requires identifying a theme and then backing it. You can achieve this by buying individual stocks or even funds which target specific sectors. Currently technology stocks are seen as a strong theme to back in today’s market rally.

This theme is based around the growing use of technology. It is expected to develop into a secondary theme, where we rely on technology to work, and even socialise from home.

Zoom Video Communications Inc whose shares are up nearly 50% since mid March, is an example of how thematic investing can be very powerful. Other ways to invest, are through a fund or ETF, which focuses on a thematic sector such as technology. Finally there are investment trusts such as Scottish Mortgage, which focus on disruptive companies across sectors.

Backing the right theme

This is the tricky part! Any investor buying into the online-shopping-is-replacing-the-high-street-theme, could of been forgiven for losing belief with AO world. Thematic investors would have identified its business model of selling white goods online as one for the future. Frustratingly the shares have range traded and worst, drop substantially over the last couple of years.

AO World is an example of thematic investing

Yet if you had bought AO World in mid March, you would be +60% as investors backed its business model in light of the Coronavirus lock down and social distancing demands.

Right theme… wrong time. 

Technology has been a huge out performer for the last 10 years, but was once a fad. The dot.com bubble of the late 1990’s is an example. Many investors lost money due to the theme not being backed by solid financials, in particular cash flow.

Fast forward to 2020 and big tech companies are sitting on large cash reserves from ever increasing sales. Sometimes a theme can be correct, but the money making (cash generation) does not necessarily follow through until later.

Future themes to back

Future themes can be divided in the ones we already know are going to become reality, such as an increase in working from home, and ones we do not know about. Working from home means firms who provide software and technological solutions will do well.

Renewable energy, though wind farms and solar panel manufacturers are clear favourites but still have further to go. BP is already active in this sphere, which suggests it sees a future in it – maybe at the expense of oil? If oil majors invest in renewable energy, then one can appreciate how powerful thematic investing can be.

Look out for government support. The German government is encouraging Germans to buy electric cars, which will be a boon to electric car makers at the affordable end of the market, such as Volkswagen.

Thematic investing high yet feeling rather low

Cannabis is seen as an exciting opportunity, as it increasingly becomes legalized. Some feel it has a future as a form of pain relief for illnesses. It is also legal to smoke in Canada. After the initial excitement, returns have been mixed. Innovative Industrial Properties inc, HEXO Corp. and GW pharmaceuticals plc are either down substantially or range bound.

HEXO corp is an thematic investment which has not come good

 

Innovative Industrial Properties is a property play which has benefited from exposure to the cannabis thematic investment story

 

GW Pharmaceuticals is a thematic investment which has proven volatile

The devil is in the detail

Another recent theme has been the rise of Environmental, social and governance, or ESG for short. This is where companies display care to the environment, its employees and to the such things as shareholder pay.

The argument being that if you not look after the above in the process of business, you will damaging parts of our society. Theoretically, companies which manage to display concern will survive longer due to having engaged staff and shareholders.

It is not completely clear how to achieve ESG compliance. How could an oil company achieve this, when their operations are inherently polluting. BP recently stated that they had an ambition to be carbon neutral by 2050.

One has to wonder if this theme and the take up by companies is part of a marketing strategy, rather than a true attempt at change. For investors you need to decide whether excluding entire sectors from your stock portfolio is worthwhile returns wise.

Conclusion

Never forget that what drives equities is earnings upgrades. For better or for worst, sometimes these upgrades are driven by creative accounting. This means you can lose everything if the theme does not come through.

The braver ones among you may be able to surf a wave of momentum trading exuberance. This could also lead to overvalued stocks in a sector that many investors feel is the next best thing. The contrarian investor will seek out undervalued stocks.

Spotting a winner-take-all theme is difficult and best left to professional investors. Their offerings in funds and investment trusts are well worth it. Keep a close eye on performance though, and check what their top 10 holdings are actually doing. Are these holdings really in line with a thematic theme?

Don’t beat yourself up if you miss the first move.

It is unlikely that investors who bought into hot stocks such as Apple and Google at the start are still shareholders today. Once you do buy and hold and enjoy strong share price appreciation, keep a disciplined approach by regularly banking profits through reducing your holding(s). You can ensure that if the theme does not eventually come through, you have still made some money!

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Louis H-P

Louis is a portfolio manager and a trader who brings a wealth of experience in private banking to The Lazy Trader. A fundamentalist and a trouble-shooter, Louis makes a firm contribution to the trading team.

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Louis H-P

Louis is a portfolio manager and a trader who brings a wealth of experience in private banking to The Lazy Trader. A fundamentalist and a trouble-shooter, Louis makes a firm contribution to the trading team.

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