New research from BNP Paribas Asset Management’s Quantitative Research Group delves into thematic investing strategies. These investments target the long-term megatrends that are transforming economies, society and business models. This is the first of two extracts. It answers five questions to help investors understand the appeal and extent of, and risks involved in, megatrend investing.
What is thematic investing?
Thematic investing involves choosing companies benefiting from or promoting a structural change expected to significantly impact economies and redefine business models over time. Thematic investing trends transcend regions, industry sectors and investment styles. Accordingly, they are labelled megatrends. They include:
- Demographic shifts
- Social or attitudinal changes
- Climate change
- Resource scarcity
- Economic imbalances
- Technological advances
- Regulatory or political changes.
These trends offer attractive investment opportunities, but as always there are risks and important portfolio considerations.
Is there an interest in thematic investments?
Despite recent struggles, thematic investments are here to stay. According to Morningstar data, global assets under management in thematic funds reached USD 579 billion at the end of June 2024, up sharply from USD 112 billion 10 years ago. In Europe, AUM stood at EUR 336 billion, up from EUR 54 billion 10 years ago.
While thematic funds have typically focused on equities, there is a growing trend to address themes in fixed income and other asset classes.
In a survey of institutional investors, Greenwich Associates reports that about 60% of respondents are already using sustainable thematic investment strategies in fixed income, and 50% in alternatives.
Is thematic investing only about growth companies?
When investing in equities or corporate bonds, the focus is not necessarily only on growth. Some themes can be accessed via ‘defensive’ assets such as public infrastructure.
One should note that when assessing actively managed thematic funds, any style bias will also partly depend on the fund manager’s investment approach. A manager could have a large- or small-cap bias, or value instead of growth bias, when looking for companies related to a theme.
What are some types of themes?
A theme may involve a group of companies that can disrupt a given industry because of cost or size advantages. New products or services can have a broad impact, too, as does regulatory protection. Any development that can give certain companies a significant advantage which allows them to disrupt an industry can be the basis for themes.
In recent years, globalisation, regulation & de-regulation trends, digitalisation & innovation, and the energy transition have underpinned themes. These developments have played an important role in making certain industries susceptible to disruption.
What are the risks?
Thematic investment is a form of active portfolio management. Thematic portfolios can be concentrated in just a few companies expected to become future leaders of a given megatrend. The composition of the portfolio may be notably different from that of the index. For that reason, ‘pure play’ strategies can lead to portfolios with a high tracking error relative to traditional, broad market capitalisation indices.
As mentioned, active investing in themes also often creates biases towards sectors, countries or styles. Predispositions can influence the tracking error significantly.
Looking at the composition of the tracking error relative to the market index, part of it can result from a focus on a limited number of sectors affected by this theme.
Another contribution comes from not investing in all stocks in the targeted sectors, but only a selection of those companies expected to benefit the most from the disruptive technology trend.
