Thematic investing experienced a massive surge in popularity in early 2020, peaking in 2021. According to Daire Dunne, manager of the Emerging Market Development Fund at Wellington Management, this period could be described as “an era of growth driven by governments worldwide stimulating the global economy as we emerged from COVID-19 lockdowns.” We discussed with him what has happened to thematic investing and what to expect from it in this post-COVID era.
Why did thematic investing slow down?
Technology and e-commerce boomed during the pandemic, accelerating the digital transformation of many goods and services. Awareness of climate change increased, leading to a new wave of demand for sustainable investments. Cryptocurrencies and blockchain captured headlines. Investments flooded into healthcare and biotech companies as the world rushed to develop COVID-19 vaccines. Lastly, remote work changed how businesses operate. These combined trends accelerated many long-term structural changes that thematic investing typically targets. Many thematic portfolios that saw the largest inflows were concentrated in these trends and performed well with high beta and growth footprints. However, much of this boom reversed in 2022 as rising inflation and interest rates dampened equity market returns, leading to concerns about global economic growth and the possibility of a global recession.
Did thematic investing disappoint investors?
The growth style significantly underperformed value, and many thematic portfolios faced a challenging period in returns. In our view, this decline was more due to a factor effect (in this case, growth) in thematic portfolios rather than thematic investing itself. Another obstacle was related to the purity of exposure in these portfolios: although these portfolios were labeled with a specific theme, the components were largely similar (which amplified factor biases). This led to the general misconception that thematic investing can be too concentrated, too growth-oriented, with high risk and high return.
Is thematic investing out of fashion?
As risk appetite has diminished over the past two years, so has interest in thematic investing, with investors opting for perceived “safer alternatives,” such as cash, fixed income, high-quality equities, and value-oriented equities. We believe there is a disconnect in this regard, as not all thematic portfolios should be considered growth portfolios. There is compelling evidence that some global trends can be captured with value portfolios, provided investors remain disciplined about thematic purity as they build their exposure.
Speaking in general terms, we see that the most discussed themes are technology/sustainability and AI. What about the other themes we’ve heard about for so long?
When we delve into thematic investing, we view the set of opportunities through an economic development lens, focusing on the drivers of global structural changes. We spend a lot of time analyzing the political support for the structural trends we identify. Our analysis, which began over a decade ago, identifies three areas of structural change related to: innovation, sustainability, and inclusion.
What themes are currently in demand?
A key topic we have been discussing recently with our clients is deglobalization, nationalism, and the resulting increased focus on resource security. The lockdowns reminded countries of the importance of self-sufficiency for essential supplies. With rising geopolitical tensions, we are seeing a renewed focus on nearshoring critical supply chains and prioritizing resource security over economic efficiency. Our clients have shown increasing interest in our Strategic Security theme and our Next Generation Energy approach. These themes also have interesting factor footprints in their underlying exposures, spanning growth, core, and value.
Are emerging market themes among these?
Within the Emerging Markets Development strategy, we have exposure to these structural themes through our Automation and Robotics theme, which would benefit from the growing demand for manufacturing equipment as countries nearshore supply chains, and our Environmental Awareness theme, which invests in transitioning energy sources and renewables. Over 80% of global manufacturing still takes place in emerging markets, making the region a crucial player in thematic investing.
How are investors using thematic strategies in their portfolios?
Thematic investing would serve as an attractive alternative source of alpha. Thematic portfolios tend to be less correlated with market cycles and span multiple countries and regions. Thematic portfolios can also have different risk profiles and factors, making them a good complement to existing allocations and providing additional diversification benefits.
What can emerging market thematic equity strategies bring to investors’ portfolios?
Our Emerging Markets Development strategy is suitable for investors seeking an alternative to traditional exposures in this market segment. As such, the Emerging Markets Development strategy will typically have lower sensitivity to the growth cycle and a lower correlation profile than traditional emerging market indices. The diversification achieved through the portfolio construction methodology can also result in a more attractive profile in bear markets over time.
What are the predominant themes in emerging markets?
Through our strategy, we have identified themes from an economic development perspective, primarily in the three areas of structural change described earlier: innovation, sustainability, and inclusion. In this sense, the team has determined the themes it finds most attractive based on positive policies, profitability, and the purity of investment opportunities within the theme.
For Marcelo Soba
