Thematic Investing: A New Way to Diversify Your Portfolio
Diversity is important to a stable, successful investment portfolio. As old ways of diversifying lose their power, thematic investing has emerged as a strong alternative.
Why Thematic Investing?
A diverse portfolio is the best way to ensure the stability of your investment income.
Investing in a limited group of assets can lead to big returns but can also lead to huge losses if that part of the economy declines.
By investing broadly, you ensure that a fall in a single sector or region won’t ruin your portfolio.
Traditionally, one of the most common ways to diversify was geographically.
By investing in assets from different parts of the world, you got returns from varying economies, giving you access to a range of outcomes.
But globalisation has reduced the diversity of results. Major equity markets now track closely to one another.
A geographically diversified portfolio is unlikely to protect you from a downturn in one region, as that downturn will be replicated elsewhere.
And with trade wars looming, regional economies are likely to take a big hit. So what’s the alternative?
What is Thematic Investing?
One strong option is a thematically diversified portfolio.
Thematic investment means picking assets that profit from related work.
For example, you might pick companies that work in security, sustainable agriculture, or robotics.
By investing in a group of assets that are expected to perform above average within their theme, you can benefit from growth in that sector of the economy.
Thematic investing means looking at the bigger picture. You’re investing based on big global economic trends. This leaves you less exposed to short term economic cycles.
This also means working on a longer timeline.
You’re depending on trends which may play out over the course of a decade or more, as society changes and businesses supporting that shift emerge as winners.
Companies supporting such important changes will often suffer the least from regional economic downturns, as their significance outweighs market trends.
Some funds invest only in a single theme.
If you want a more secure portfolio then you can diversify by investing in several. This protects you if one of the predicted trends doesn’t pay off or takes longer to emerge.
As with any diversified portfolio, variation is key. It’s important not to let a single holding represent too much of the portfolio or of a fund that you invest in.
Pick a few themes and then vary your assets within them.
How to Pick Your Themed Investments
When picking your themes, consider the trends that will shape our world over the next ten to twenty years.
For example, you might pick the ageing population as one of your themes and invest in companies that will profit from this.
A little research outside the usual market sources can be hugely helpful. Futurists – specialists in predicting where society and technology are going – can be invaluable sources of insight.
Look at the writing of thinkers like Anne Lise Kjaer, Michio Kaku, and Jamais Cascio.
Identify futurists who are discussing areas of interest to you and see what changes they are predicting. Then develop investment themes around these trends.
When picking your themes, look for trends that will affect supply and demand of certain resources and services.
Where in society will demand outstrip supply in the near future, creating increased profit for the companies involved?
When picking your specific investments, look at both developed and emerging economies.
Though we think of developed economies as tech leaders, emerging economies are also affected by technological and social trends and may respond to them in big ways.
As well as individual investments, look for thematic funds that fit your portfolio.
Don’t over invest in a single stock, and check which stocks your funds are investing in, as their combined investments could leave you too reliant on an individual asset.
The Downsides of Theme
Like any investment strategy, themes have their downsides.
They’re not good for providing short term payoffs, as they rely on long term trends.
They don’t have the same strong monitoring tools that have been created for regional investment, as fewer investors are focused on theme.
Individual thematic funds may have greater downsides.
They often have higher ongoing charges than comparable funds. Some bring greater risk because of their narrow focus and may not be suitable for a cautious investor.
If you’re happy focusing on long term growth and you want to outperform the market, then themes are a great way of tapping into the real economy and profiting from social change.
By creating a thematically diversified portfolio, you can combine the benefits of thematic investment with the security of investments that aren’t reliant on a single sector.
Paul Connolly
Paul Connolly has been a journalist for more than 20 years, as a reporter and editor for Argus Media, Reuters, The Times, Associated Newspapers and The Guardian. He has covered Islamic Finance for Reuters in the 1990s. Paul has since helped launch three newspapers, as well as reported from Tokyo, Los Angeles and Stockholm.
