How To Be A Successful Thematic Investor

Summary

• With the rise of funds like ARK Innovation, thematic investing is becoming more popular
• The Tri-Polar World and Global Risk Nexus provide frameworks for investing thematically
• Currently, they suggest a 20% allocation to thematics which include investing in sectors like infrastructure, clean energy and crypto.

Thematic investing is a hot topic. Bloomberg recently noted that thematic ETFs tripled assets over the past three years to $180bn and are now bigger than any sector ETF (Chart 1). And Bloomberg forecasts that thematic ETFs could double assets again to reach $500bn by 2025, becoming bigger than all US sector funds combined and highlighting the limits of legacy sectors and styles. But how might you invest thematically?

The Tri-Polar World and the Global Risk Nexus

I use two frameworks: the Tri-Polar World (TPW) and the Global Risk Nexus (GRN). Globalization as known in the early 2000s is dead, a view that the GFC, Brexit, and Trump’s ‘America First’ rhetoric reinforced. Replacing globalization is not nationalism but rather regional deepening or integration in the three main poles of Asia, Europe and the Americas – or what I call the Tri-Polar World (TPW). This integration has five drivers: each region’s growing ability to self-finance, self-produce, self-consume, self-innovate (tech), and self-protect (climate).

Today, everything I see suggests that regional integration is evolving rapidly and in symbiosis with many of the thematics. Consider the geographic response to COVID (Asia first in, first out), Splinternet and China’s drive for tech self-sufficiency, Europe’s Green Deal and its quest for strategic autonomy in batteries and semiconductor chips, and US President Joe Biden’s climate and infrastructure plan. All are regional and thematic. Therefore, the TPW framework gives investors a differentiated perspective on the interplay between regional deepening and investing thematically.

After moving from globalisation to the Tri-Polar World (TPW), we must consider how to mitigate risks. The critical ones relate to economics, politics, policy and markets across each region and globally, which I call the Global Risk Nexus (GRN). But with COVID’s advent, I added a health component; everything plainly stems from health. With health now a regular part of this GRN process, the idea of ‘COVID speed’ becomes very clear – an actionable investment insight.

COVID speed refers to all aspects of the pandemic. It is the speed of the spread, policy response, market reaction to that response, vaccine creation, and vaccine delivery (the only example of subpar speed). Most recently, it is also the speed of the fall – the collapse in hospitalizations in the UK and US. Arguably, speed has been the key component to being on the right side of the markets this past year.

The COVID speed concept well illustrates the benefit of a tried-and-true process when focusing on global macro investing. It does not mean you are always right (far from it) nor that you will never look up and say, ‘How did I miss that?’ But it does mean having a structured process by which to think about the macro inputs of health, economics, politics and policy and how they impact markets either separately or together. It is also a great setup to think thematically.

Over the past six months, I have extended this COVID speed concept beyond health to other global challenges such as climate change (the obvious one). But I believe cyber, genomics, and the emerging nexus between traditional banking, fintech and crypto are also global issues with attendant global focus both intellectual and financial.

I believe these global challenges coupled with abundant, cheap money and the replicable success of the Covid speed model represents a paradigm shift that will drive an unprecedented period of innovation. In this vein the flood of capital we have seen enter the public markets through the Robinhood bros or the IPO boom or the SPAC craze may be a bit much but may also serve to bring that future forward and into the public market realm, disrupting to some extent the VC funds who have been the financiers of the early adoption cycle. Now it’s the public market investors who have a chance to access that Innovation Curve at an earlier stage of the cycle. This of course means more risk but also more reward and supports the thematic investing process as a way of spreading one’s bets, much as a VC investor does.

Rise of Good Government

Alongside this paradigm shift, we have regime shifts simultaneously unfolding across multiple spaces: government, economics, policy and markets. In the US particularly, the shift in governance could be profound as a Biden government that believes in going both big and fast replaces a 40-year-old orthodoxy about how government is bad. In economics, we will have the kind of global growth boom unseen in 50 years. In policy, we have abandoned the slavish dependence on monetary policy to embrace fiscal policy. In markets, we have entered a bear market for UST – the first in 40 years.

Even away from crypto, the recent volatility in the clean energy, battery, and innovation space has been significant. Most themes have fallen back to November-December 2020 levels. ARK’s main ETF, for example, is off roughly 30% from its recent high. It suffered a similar decline a year ago with COVID but recovered to new highs in under three months. As I write, many segments have retraced even their little bounce of the past few weeks and are back to early March lows. Given that these themes have been developing for years and that some are still far from fruition, the broad thematic space appears to be trading as a high-beta, long-duration growth stock. I understand this on one level but also believe that the paradigm shift I referenced above is yet to be fully understood and embraced. So, the trick is to stay involved during sharp pullbacks like we have just seen.

How To Allocate To Thematics

That is difficult and leads back to portfolio construction. This can be an area of opportunity for alpha generation if one can find the right guides and structure a long-only portfolio to stay invested. I have found that pairing old and new has been effective over the past few months – old energy with clean energy, traditional banks with fintech, etc. Given these comments above regarding how the various disciplines are aligning in favour of value, this pairing also offers a way to participate in the value opportunity while investing thematically, reducing risk and staying invested thematically. Another approach would be a barbell with cheap beta on one end and more expensive thematic ETFs on the other.

There is also the opportunity to shift around within themes, reducing perhaps the more aggressive positions in favour of themes that can be either more traditional, for example infrastructure, or even more cutting edge, such as carbon. Companies and governments face increasing pressure to display their carbon emission footprints, which will accelerate the carbon offset market across the Tri-Polar World. Europe will probably take the lead this summer with its Carbon Border Adjustment Mechanism (CBAM). Over the past few months, I migrated away from the more volatile segments to infrastructure and carbon as a way to maintain roughly 20% thematic exposure while dialling down the volatility. I include a pie chart of my thematic exposure to visualize this process (Chart 2).

This is today’s question: given expectations of strong growth, another 30-40bp rise in the 10-yr UST over the year and so continued relative underperformance of big tech and the broad US market relative to ROW, how should you invest thematically? If many themes will continue to be treated as levered plays on the Nasdaq, you would want to be less aggressive. If you think the paradigm shift will drive greater investment in thematics, particularly by LT capital in the public markets, then you would want to stay heavily invested. Current oversold conditions may offer a good entry point for some. I do not have the answer, but it is the key question for me. I believe investing thematically is here to stay and has alpha-generating power; it might even be global macro’s salvation!