Inderpal Gujral, Head of Product at STOXX, discussed ideas on thematic investing at the Inside ETFs event that was held in London on Oct. 1–2, 2018. Pulse Online caught up with him to ask what is behind thematic investing and why it has emerged as a strong investment opportunity capturing a large share of ETF asset inflows.
Inderpal, what is thematic investing?
Thematic investing attempts to capitalize on broad, disruptive, compelling and often hard-to-predict trends that are changing our society. Their growth characteristics have the potential to significantly outpace the market’s average rates, and indeed this has been the case in the last few years for many if not most of the concepts we track at STOXX. The fast-advancing and changing world we live in has been a fertile background for these strong trends to emerge.
How do you come up with thematic concepts to invest in?
We currently see three interesting broad thematic ‘megatrends,’ as we call them: demographics, climate change and technology. From these megatrends, we then narrow down to several large cross-industry concepts with long-term economic impact.
On the demographics side, for example, we may consider ageing population, millennials or urbanization. Within climate change, we have identified concepts such as renewable energy and resource scarcity. And within technology, we have two groups: companies driving technological change, and companies that put technological innovation to use. Drivers of technology include artificial intelligence (AI), cloud computing, Industry 4.0 and the Internet of Things, whereas technologically-driven concepts include fintech, the sharing economy, blockchain, healthtech and e-commerce.
Each of the thematic concepts on its own has the potential to be a fantastic growth and transformation story, with social and economic consequences. In each one you can see a modern solution to an evolving world, from smart engines to electric cars, to water supply infrastructure and digital security, opening up new sources of value generation. Identifying these concepts is the starting point from which to create a portfolio that can leverage growth and replicability.
With regards to that growth you mention, how disruptive can these megatrends be?
Just to cite one example: millennials are now the largest living generation in the world. In the US, they are estimated to be three times as big as the generation before them. This brings a whole change of dynamics in business, communication, travel, etc., as each generation comes with unique characteristics. The thematic trends we identify with millennials are digitalization, healthy lifestyle, experiences and value. At the other end of the age spectrum, thanks to the phenomenon of an ageing population, it is estimated that the spending power of consumers aged 60 and over will hit $15 trillion by the end of this decade, up from $8 trillion in 2010.
So how do you design a thematic index?
At STOXX we have identified concepts that are investable using a passive methodology that observes principles of replicability and liquidity as is the case with all of our indices. The thematic concepts must be appropriately chosen considering their scope and durability, and to avoid fads. Currently the STOXX Thematic Indices family consists of indices tracking ageing population, automation & robotics, breakthrough healthcare, digitalization, blockchain, fintech, digital security, two AI indices, and an index that combines blockchain, robotics, AI and nanotechnology.
We have taken two main approaches in the design of our thematic indices. Firstly, there is a revenue-based approach, where we consider each company’s balance sheet exposure to pre-defined sectors associated with a given concept. Here we access the very granular RBICS business category data, whose detailed industry breakdown and classification results in a sectoral split that is different from the traditional GICS and ICB sectors. The revenue-based approach enables us to isolate specific concepts and provide pure exposure to a thematic megatrend.
And, secondly, we have used an innovative AI-based approach for two of our thematic indices, the STOXX® AI Global Artificial Intelligence Index and the STOXX® Global Blockchain Index. These indices use sophisticated machine-learning and computational-linguistics technology to analyze intellectual-property (IP) patents for each company across the world and conclude how important each concept is to those companies. For example, for our AI-based blockchain index, we mine the global patents landscape to find out which companies’ businesses are most exposed to blockchain patents, as well as which companies have contributed the most blockchain patents to the world. These IP exposure and IP contribution scores are the factors that will determine whether stocks are included in the index.
Given the dynamic pace at which our society is changing, we are always considering new thematic indices as we continue to exploit the possibilities that these megatrends offer.
What does a thematic index look like relative to a traditional, market capitalization-weighted one?
That’s an important point, as a thematic portfolio is likely to display some fundamental differences to a traditional one. One of the key differences is that megatrends usually span several years and business cycles, so they can be more long-term in their growth projection assessments compared to the more regular earnings calendar of established large-cap stocks. Thematic portfolios are therefore agnostic to the sector and cyclical views of traditional equity allocation strategies.
Another distinctive aspect of thematic investing is that the portfolio is based on a predictive assessment of future growth, as opposed to past performance. Finding the winners and losers of a trend that may be emerging is key to a successful thematic strategy.
What are some of the risks of thematic investing?
Generally speaking, thematic investing is a high growth/high risk concept, and that is something to bear in mind. A thematic portfolio is likely to have higher-than-average volatility, be more prone to falls and exposed to the fat tail risk of the market. Investors should understand that those are the characteristics of the investment and should be aware of what to expect.
- iSTOXX® FactSet Ageing Population
- iSTOXX® FactSet Breakthrough Healthcare
- iSTOXX® FactSet Automation & Robotics
- iSTOXX® FactSet Digitalisation
- STOXX® Global Fintech
- STOXX® Global Artificial Intelligence
- STOXX® AI Global Artificial Intelligence
- iSTOXX® Developed Markets B.R.AI.N.
- iSTOXX® Yewno Developed Markets Blockchain