Thematic Investing: More Than Just a Good Story

What You Need to Know

Big global trends such as technological disruption, urbanization and the energy transition offer exciting thematic stories for equity investors. But for thematic investing to work, investors need clear criteria to define lasting themes and a coherent process for building portfolios with real return potential and thematic purity. Above all, thematic portfolios must be constructed with the same rigor, discipline and risk-management controls as any active equity portfolio.

In an increasingly complex global marketplace where short-term thinking has become the norm, considering the transformative forces that are reshaping the world can offer investors a compelling approach to strong long-term return potential. Thematic investing provides a differentiated way to generate wealth in contemporary markets by strategically envisioning the future through an investment portfolio while tapping into the powerful, universal appeal of a good story.

From technological disruption to the energy transition, people naturally connect to stories about change that can foster investment returns. Yet the simplicity of a compelling story may be misleading. Translating a trend into investment success requires identifying shifts that will persist, developing a thematic opportunity set and carefully selecting securities that are likely to create sustainably higher profits over the long term. Investors must also pay close attention to the special nuances of thematic portfolio construction while thoughtfully evaluating how the strategy fits within a broader allocation.

The quest for new sources of return potential has made thematic portfolios popular in recent years. Attractive themes for equity investors span technological and social issues as well as challenges in the physical world, such as infrastructure development, climate change, and transformations in agriculture related to food scarcity and production.

Well-defined thematic trends should be related to long-term policy, physical or social shifts that aren’t always easy to spot as they begin to unfold. Generally, these types of themes have tended to prompt long-lasting capital investment cycles (Display) as companies see opportunities for growth. Our research of select major shifts over the past three decades shows that as each theme has progressed, the associated sectors have outperformed the broad benchmark by a wide margin. For example, during the fossil fuel supercycle that ran from 1999 to 2014, the energy sector outperformed the S&P 500 by 7% per year. More recently, technology stock returns outpaced the US market by a similar annualized margin during the cloud and e-commerce cycle that began in 2009.

But identifying themes is just a starting point. It’s easy to look back and identify periods of powerful investment cycles, but much harder to predict when a theme will take off—and when it will run its course. Critics argue that the appeal of a good story doesn’t always lead to good investments. They’re not entirely wrong. For thematic investing to work, we believe investors need clear criteria for defining lasting themes and a coherent process for building portfolios with real return potential. Above all, thematic portfolios must be constructed with the same rigor, discipline and risk-management controls as any active equity portfolio. In this paper, we explore the principles of effective thematic investing to help investors make informed choices about thematic portfolios and incorporating them into a broader asset-allocation strategy.