SUMMARY
Thematic investing has attracted significant inflows of capital in recent years. We consider the potential of building exposure to themes in portfolios.
Powerful forces are at work all around us.
They include demographic changes such as aging populations, countless technological innovations, the transition away from fossil fuels, and strategic rivalry between the world’s biggest economies.
These forces have the potential to reshape the world as we know it, upending how we live and work.
As a result, they may also have a major impact on wealth, disrupting entire industries, and creating winners and losers among companies.
For that reason, many investors seek to reflect such forces when they build portfolios, adding exposure to assets that may potentially benefit, while trying to avoid those that may lose out.
In recent years, an increasing amount of capital has flowed into thematic strategies – figure 1.
Figure 1. Global thematic equity funds assets under management
Source: Citi Wealth Investment Lab, Bloomberg, using semiannual data from June 2004 to June 2024. Assets under management for all equity funds classified by Bloomberg as thematic. Past performance is no guarantee of future results. Real results may vary.
Thematic investors’ goals are typically a combination of seeking higher returns, mitigating risks (e.g., by avoiding potential victims), and increasing the diversification of their portfolios.
What is thematic investing?
Thematic investing begins with identifying investment themes.
There is no hard-and-fast rule as to what constitutes a theme, although they tend to share certain characteristics.
They are typically long-term in nature, i.e., likely to be in force for many years to come.
They usually relate to the sort of major transformative forces mentioned above.
And they are widely recognized by other investors.
Equity index providers – such as MSCI, FTSE, and S&P Dow Jones – nowadays produce indices that capture major themes and subthemes.
The themes selected can be broadly based, e.g., an index that tracks companies involved in the digitization of the economy, spanning cloud computing, AI, robotics, e-commerce, 5G communications, education technology, and more.
Equally, they may focus on one aspect of the broader theme, e.g., cyber security within digitization.
In turn, the managers of active thematic portfolios may use such benchmarks to compare the performance of their own strategy.
And exchange traded fund providers may launch vehicles that seek to track the performance of the index providers’ baskets.
Despite a common theme, different index providers and thematic portfolio managers may have very different exposure in their baskets and portfolios.
This could be for many reasons. For example, their definition of the theme or sub-theme may be distinctive. The data they use to measure a company’s involvement in the theme may also differ. And their index methodology may include some investments and exclude others for reasons unrelated to the theme.
How does thematic investing fit into portfolio construction?
If you already own a broad selection of global equities, for example, you already have exposure to a wide range of investment themes, knowingly or unknowingly.
For example, if you have a passive strategy that seeks to track the S&P 500 Index, you would be invested in such areas as artificial intelligence, the future of healthcare, and the energy transition.
However, thematic investing involves a conscious decision to emphasize investments that relate to a specific theme or themes.
You would thus build greater exposure to these themes than the average investor, be they active or passive.
The thematic element of a portfolio essentially seeks to work within your long-term plan.
Thematic investing can span many asset classes.
For example, there are theme- and sub-theme-related strategies available within fixed income, commodities, private equity, and real estate.
More so than many other approaches, thematic investing can help shape an entire portfolio, therefore.
Does thematic investing work?
Thematic investing can potentially complement a portfolio’s risks and returns.
However, with so many different themes and strategies that seek to exploit them, generalizing about thematic investing’s effectiveness is harder.
Whereas there have been many studies of other approaches – such as value investing (buying cheap assets) or momentum investing (buying recent winners and shunning losers), there aren’t decades-worth of data to help assess the risks and returns for thematic investing.
Depending on the themes involved, thematic investing may help to seek diversification in a portfolio.
After all, it can span multiple industries, countries, and asset classes.
For example, an allocation to the theme of digitization could build multiregional exposure to:
- Utilities – e.g., owners and operators of clean energy for powering data centers
- Basic materials – e.g., via miners of copper – an essential input for much digital infrastructure
- Real estate – e.g., via strategies targeting data centers and e-commerce warehouses
- Telecommunications – e.g., 5G network providers, managers, and operators
- Financials – e.g., fintech companies offering disruptive financial services
- Consumer discretionary – e.g., digital entertainment services and online retailers
- Industrials – e.g., the makers and beneficiaries of robotic technologies
Nevertheless, like returns, diversification is not an automatic feature of thematic investing. Instead, investors need to think carefully about the themes and the combination of themes that they hold for this purpose.
It should be noted that diversification does not mean that your portfolio cannot lose value.
What are the risks of thematic investing?
Thematic investing comes with all the same risks as non-thematic investing.
For example, investments may prove to be illiquid or volatile. The companies involved may deliver disappointing results, suffer product failures, or enter financial difficulties.
Some of the risks can be accentuated with thematic investing, though.
Especially where there is a lot of excitement about a theme, the valuation of related assets may get pushed up higher than is warranted, leading to future underperformance.
Themes that are too broad or vaguely defined may include such a breadth of investments that returns end up resembling those of market indices.
Themes that are too narrow, on the other hand, may end up being hard to invest in or overly concentrated in a few investments.
Just because investors correctly identify a transformative theme, that doesn’t mean the related investments will necessarily do well.
Early winners from emerging themes often fail to stay the course.
Take the late 1990s, when many correctly believed that the internet was going to transform business and everyday life.
However, a lot of the first generation of internet related companies failed to capitalize on what followed, leaving their investors with disappointing returns.
Thematic investing at Citi Private Bank
Citi Private Bank believes that thematic investing can complement a broadly diversified core portfolio.
Our Chief Investment Office, strategy and portfolio manager research teams analyze the secular forces that they believe may have most bearing on the global economy and markets.
The resulting themes appear in our Wealth Outlook. In our recent edition, we explored:
- AI-propelled digitization: The race for picks and shovels
- Cleaner and smarter: How AI can help fuel the energy transition
- Healthcare’s improved prognosis
- Intensifying US-China polarization: Navigating risks and potential opportunities
These and themes can be introduced to portfolios in many ways, as part of core portfolio holdings or opportunistically.
They span multiple asset classes and can be implemented by proprietary or third-party managers, as well as via capital markets strategies.
