What is Thematic Investing?

Thematic Investing

Hey everyone! How are you all? So recently I came across something called Thematic Investing. I had never heard of it and consequently it piqued my interest. I did a bit of research and here’s what I have learnt:

What is Thematic Investing? It is basically investing in themes by researching on trends rather than making investments based on the past performance of the market or a company’ s fundamentals. It is a forward-looking top-down approach. Unlike the relative investment strategy which assigns weights in a portfolio based on market capitalisation, it involves identifying and investing on emerging opportunities that span across economic sectors and regional boundaries. Fads are avoided and only after a thorough research securities are picked. It seeks to invest in baskets of securities that are exposed to long-horizon structural changes. Examples of such themes are Clean Energy, and Cyber Security. This requires a fundamental understanding of the impact of long-term social, political and economic trends on a region or sector. This will help in identifying prospective opportunities, their associated value and risks. To put it in simple words, thematic investing is identifying and researching future trends and investing in them.

So, how is it different from the relative investment strategy? A report by McKinsey illustrates some of the differences:

Relative vs thematic investing

How to approach Thematic Investing:

  1. Identify the right trends: This part is essential and an investor should choose a trend that he’s comfortable in and aligns with his values. To do this, he should consider all relevant themes, understand them, prioritize them and then make a few selections to research further. It’s crucial to determine whether a trend is structural, short-term or speculative in nature, so that fads can be avoided.
  2. Identifying associated themes: After identifying trends, the associated-themes must be researched upon. An analysis of the possible impact across regions and time needs to be done. The investor should rapidly identify the effects of a trend on revenues and profit pools in affected subsectors. This will help in getting detailed insights and a fair idea of his exposure. For example, growing energy consumption in emerging countries can be a powerful trend, the investor can investigate the market for solar energy in India.
  3. Prioritize and Choose Themes: According to McKinsey, four questions should be asked about each theme, for this process. Of those 4, I’ll list out only 3 as I found those fit for individual investors:
    • Is the theme investible?: Investor should assess the profitability and the risk profile of the theme and also should try to identify other asset class that might turn out to be profitable due to direct or indirect impact of the theme.
    • What is the risk that the theme will not materialize?: Investor should focus on offsetting the risks and understand what the risks could mean for the investment.
    • Does the theme fit with the current portfolio construction and investment policies?: The investor should choose themes which can be easily integrated with his portfolio and monitored. This can provide a direction and focus to the thematic investing approach.
  1. Develop an investment thesis: After prioritizing themes, the investor must create a proposition describing how and why the investment in the themes will create value over time. According to McKinsey report, this typically involves two stages:
    • Developing an understanding of the associated value chains including the key players, industry dynamics and performance drivers.
    • Developing a perspective of how the industry dynamics will be impacted by the theme.
  2. Build the portfolio: After developing a clear thesis, the investor can screen asset classes to identify the strongest ones that will generate value over time. The assets should have solid industry fundamentals and high exposure to the theme in order to offset the long tenure and associated risk. The portfolio should be well-balanced with each asset given its due proportion according to the investment objectives and goals.

Thematic investing offers an alternative approach to traditional investing approach. It utilises the strengths of the institutional investors to the maximum and provides an opportunity to gain understanding, knowledge and insights necessary to form informed opinions for investment.

Invest now…in the future…for the future.

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