Successful thematic investing requires a broad diversified approach picking up the growth within the theme rather than relying on finding the next Amazon or Google argues Howie Li, head of ETFs at LGIM.
The firm has continued to expand its range of thematic ETFs with the launch of artificial intelligence, healthcare breakthrough and clean water strategies earlier this month.
Speaking to Global Investment Megatrends, Li says that traditional index investing has tended to follow themes that are responsive to what has happened in the past.
He argues that it is much better to identify how trends such as technology, demographics and the need to shift to clean energy are now driving structural and foundational changes in business models.
LGIM’s sectoral approach aims to identify the sectors of tomorrow where industries are changing so much, that they are reclassified or redefined rather than the more mature markets, where things are more ‘saturated’ in terms of growth opportunities.
“Everyone would love to pick tomorrow’s Amazon and tomorrow’s Google. Yet I can throw out some names that everyone would not want to pick – tomorrow’s Ericsson or tomorrow’s Nokia.
“We are trying to give an exposure to the long-term theme with a diversified portfolio that allows you to get exposure to the general growth of this theme, rather than growth outside of this projection for any given company. We want to be diversified, yet still with a very pure access or correlation to the theme that you’re trying to capture.”
Robotics theme promises huge growth
In the case of the early growth of robotics that would mean targeting the double-digit growth predicted annually – with some predictions of 20% – rather than necessarily finding the outperforming, outlying stock.
It also requires identifying how a theme will play out over five, ten and 15 years.
But to play these themes, LGIM says it is accessing and analysing research often not considered by ‘traditional’ fund managers.
Li says: “Traditional investment managers tend to focus on the listed information data that they have, as well as sell side analysts’ reports from investment banks.
“We are working with dedicated experts that understand and sell information and research to people in that industry.”
For example, the asset manager works with a research firm Transport Intelligence that works closely with people in the logistics space to understand issues such as how much warehouse space they have got, what the real estate is, and how many vans they own. This also helps inform the manager how, where and why transformational change is occurring and its impact.
Looking specifically at the e-commerce logistics ETF, he says this is not about focusing on individual companies selling goods online but on how disrupted the distribution model is, where firms have to completely restructure and redefine how they run their business.
“Growth is multi-year and there is lots of technology that’s going into that space.”
“Not a lot of investment managers have ever tried to understand that information, often because that data is not set up in a way that is easily understandable.
“We spend a lot of time taking that information and deconstructing it to use within our investment strategies.”
“We want to be diversified, yet still with a very pure access or correlation to the theme that you’re trying to capture.”
Eyes on the private market to understand the trend
It also means that to really understand a developing theme, LGIM also gathers information about private firms to give an overall and coherent picture of how a theme is developing and influencing a sector, before it becomes available to invest in through an IPO or M&A activity.
“What is crucial for us is understanding through deep research and a dedicated lens of focusing on say robotic automation and AI who are the companies involved in both the private space as well as the public space.
“That then gives us a very bottom up approach, and allows us to identify the investable universe, rather than traditionally looking for sectors and saying ‘Okay, well, this company is in the tech sector’. We want to see within the tech actor, who’s doing robotics and who’s doing AI well.”
With clean energy, while there is a broad acceptance of the move away from fossil fuels, Li says it makes sense to focus on storage and distribution of that energy.
The eight thematic strategies tend to invest in small and medium cap companies. Large caps are not excluded, and a big conglomerate could, of course, be a key player in AI or in the cyber security sector.
However, selection would also depend on factors such as revenue contribution and how much they are reinvesting in R&D in that area or theme.
“We’re trying to capture a high connection to a return profile caused significantly by that theme or resulting only from that theme itself and the best measures to look at are revenue, but also reinvestment.”
Following these themes in such a broad sense also means that the funds are not particularly news-event driven.
“You hear of a company coming under a cyber-security attack, one company falls in price, another does better, yet all this risk is drawing attention to the fact that the protection of our data continues to be extremely important.
“It is not about one single player at this moment in time, during this high growth phase.”
Meeting the sustainable development goals
The asset manager also believes that the theme approach can allow it to deliver on some of the UN’s social development goals.
“Around the issue of clean water, traditionally, investments have been hugely focused on utility companies and less on making sure we’ve got a sustainable water resource for us to use. It’s not just about desalinisation, but also about cleaning up after ourselves.”
That can include cleaning water after use by the textile industry or removing micro plastics.
“It’s very difficult to find directly investable, opportunities that match exactly with the 17 sustainable development goals.
“Yet when you take a look at using a thematic approach through the clean water lens there is a direct clean water and sanitation sustainable development goal. Our product is directly focused on doing that.”