Thematic Investing Essay
by David S. Krause, Marquette University
February 2022
What is thematic investing? The term is first believed to have been coined
by Kevin O'Leary, a Canadian television personality who is a regular panelist on
Shark Tank. The business magnate, investor, and entrepreneur gave the first
televised presentation on the concept and benefits of thematic investing on
CNBC's Squawk Box in July 2004.
Thematic
investing is an approach which focuses on predicted long-term trends rather than detailed
analysis of specific companies or sectors, enabling investors
to access structural, one-off shifts that can change an entire industry. Thematic investing focuses on investing in
stocks based on underlying risk factors. These factors can be derived from
external sources, such as economic trends or fundamental sciences. Frequently,
these risk factors change, and new themes become available. Sometimes these
risk factors drive stock valuations significantly higher benefiting thematic
investors; however, as witnessed in January 2022, it also can be a dual-edged
sword with dramatically lower valuations over short time periods.
Thematic investing can be combined
with other investing strategies, such as fundamental analysis which involves
the evaluation of stocks based on a company’s financial condition. Thematic
investing treats economic data as a key indicator, while a traditional
fundamental investment analyst focuses heavily on long-term company fundamentals.
This traditional approach to investing involves the use of discounted cash flow
and relative value comparisons with related stocks in order to evaluate their investment
merit. On the other hand, thematic investing examines stock opportunities
relative to their present situation.
In short, thematic investing is
considered to be a niche investment strategy. It differs from the traditional fundamental
valuation approach in that the focus is on analyzing an industry or technology rather
the detailed analysis of a specific company.
What is secular investing? This type of investment strategy involves the
identification of 3-to-5-year waves that are often referred to as cyclical trends
or movements. If the overall direction of the market in a longer-term wave is
down, this is called a cyclical bear market. While if the overall direction of
the market over a longer-term period is up, then it is called a cyclical bull
market. For example, during the latter part
of the 2010s and early 2020s, a cyclical bull market existed.
Secular investing involves attempting
to time cyclical markets. Often times, the long-term secular movements that
drive these patterns are nearly impossible to predict. Sometimes a secular
trend can be anticipated, such as when a change in government monetary and
fiscal policies is clearly announced. Other times a secular trend can be driven
by macro factors such as demographic patterns or new technological innovations,
as was the case with the Internet in the late 1990s.
It is possible to employ thematic
investing within a secular trend. For example, many secular themes revolve
around demographic, behavioral, and macro trends that can be driven by certain
economic, social, political, and technological changes. Behavioral trends can
be impacted by cultural, economic, and environmental events, while macro trends
are those which are driven by global forces that impact economies, cultures,
societies, people, and the environment.
Is Cathie Wood of ARK Investment a thematic or secular
investor? Her firm, ARK Investment Management, employs a
classic thematic investment strategy. ARK’s approach, which focuses on
predicted long-term trends rather than a specific company’s or sector’s
fundamentals, enables investors to access structural, one-off shifts that can
change an entire industry. Interestingly, some people call Cathie Wood to be a
secular investor because she invests in stocks regardless of the overall trend
and pays little attention to valuation. However, ARK invests in companies that
disrupt business in one way or another – they do not invest basic on secular
trends.
Some examples might help understand
Wood’s approach. For instance, ARK invested in Alibaba, which is a business
that disrupted the way people sell and purchase products online. Thematic investors
put their funds toward industries that will disrupt other businesses in the
future. Presently, ARK is investing in companies that make and sell
cryptocurrencies believing that this technology is going to disrupt the traditional
banking and financial services industry. Another example of a disruptive
innovation that ARK is currently investing is artificial intelligence (AI),
which is a technology that experts believe is likely to disrupt many industries,
including the manufacturing and financial sectors.
What is the
relationship between disruptive innovation and thematic investing? There
are many people who believe that disruptive innovation is the major driver of
change and that it is the driving force behind the technological revolution. Disruptive
innovations such as social media, artificial intelligence, big data, and
blockchain are influencing the lives of billions of individuals worldwide. These
technological innovations are able to change how individuals interact with each
other, with their environment and conduct commerce.
For example, blockchain technology is
a disruptor that potentially will revolutionize and decentralize the financial
sector. The World Economic Forum has predicted that blockchain technology will
have a substantial impact on the global economy by 2025. Therefore, thematic
investing in this technology can help investors benefit from the upcoming
developments likely to be felt across multiple sectors.
Unlike traditional fundamental
investing that tends to be focused on analyzing a company in detail within a
specific sector, thematic investing is much broader and not as concerned with a
specific sector. Thematic investing is more involved with understanding the
potential future disruptions that might occur with breakthroughs in solar
energy, biotechnology, and FinTech. Conversely, traditional investing involves
more conventional sectors like banking, insurance, utilities, and energy
companies.
Can traditional
and thematic investing co-exist?
Certainly, both value and thematic investing seek to minimize risk and maximize
returns within a portfolio context. Therefore, investors in both strategies seeks
investments in companies that are considered to have solid fundamentals and
good future growth potential. Traditional fundamental and thematic investors believe in investing in companies with strong
management teams and sustainable balance sheets. Therefore, investors in value
and thematic investing believe in owning companies that are financially
sustainable and well-managed. Both investing
strategies can be complementary to each other and are supported by traditional
financial and economic theory.
Nevertheless, there are some areas
where the two approaches differ. Value investing is not concerned with a
specific theme but seeks to invest in companies that are considered to be
undervalued. A traditional fundamental value investor aims to invest in stocks
that are undervalued because their intrinsic value is higher than their present
stock market value. Thematic investors, however, are looking for a specific
theme or technology and care more about the long-term growth potential than
current valuations.
Is thematic
investing more volatile than fundamental investing? Yes, because there are specific thematic
strategies, such as Ark’s Genomic Revolution or Autonomous Technology and
Robotics funds, these tend to be less diversified than traditional portfolios,
and thus more volatile. Sometimes thematic funds will develop a strong momentum
trend as market timing investors jump in. For example, if Cathie Wood creates a
new Ark fund based on an emerging technology or innovative disruption, many
other investors may follow her lead creating strong momentum. These momentum
investors will move into and out of various themes depending upon the
short-term performance that results in more volatile returns over time. This
short-term behavior can also lead to greater volatility of thematic funds.
Are momentum and
thematic investing the same thing?
Momentum investing is the practice of buying stocks that have recently
performed well. This approach is based on the idea that some stocks that are
rising can generate a dramatic upside over a short period of time. Momentum
investors basically believe that stocks that did well in the recent past will
continue to do well in the future. This behavioral bias leads momentum
investors to buy stocks that did well recently but they also exit stocks as
quickly if performance lags.
Both momentum and thematic investing
involve buying stocks based on recent trends; however, two fundamental
differences exist. With momentum investing, investors look for stocks with a
reputation for performing well over a range of economic conditions. When they
enter the market, they will either sell or remain there. With thematic
investing, on the other hand, investors buy and hold stocks for longer periods that
they believe will outperform the overall market into in the future.
Two trends characterize both momentum and
thematic investing. First, these strategies tend to be uncorrelated, meaning if
one succeeds, the other might not. Second, thematic investing involves a more
qualitative analysis looking to the future, while momentum investing focuses on
more quantitative or past technical charting data. Academic researchers have conducted
extensive research on momentum investing and have generally found that most are
poor relative performers over time. The findings reveal that momentum
strategies tend to be characterized by a lack of persistence and underperform relative
to other investment approaches.
What is the
conclusion? Disruptive technology
and innovation appear be occurring more frequently. Thematic investing seeks to
identify future ‘disruptors’ early in their lifecycle. This type of investors
needs to remain vigilant in identifying new ideas, approaches, and
technologies. These investors have to remain agile and adept at evaluating the
potential for new technologies if they want to succeed. Investing in disruptive
technology can be challenging for those who love traditional firms which is why
funds like Ark Investment Management have grown in popularity.
Technology trends constantly change,
and as a result, thematic investors are continuously searching for stocks that
can profit from new markets and trends. The future of disruptive technology has
many people searching for the next Amazon or Google, which is not as easy as it
seems. Because today many business practices appear to be shifting, including macro
and demographic trends, thematic investors must be on the lookout for companies
who are emerging or re-inventing themselves. New technological innovations,
which were previously only dreams, are reshaping business and the economy. Thematic
investors are wise to find and identify these future disruptors.
