On the one hand, they are attractive because they follow so-called megatrends, which are causing lasting change in the world we live in. On the other hand, they are often associated with topics that affect our everyday lives and are thus easy to grasp.
A current example is the energy transition theme, which has gained importance because of the growing interest in sustainability, the increasing evidence of climate change and, last but not least, the consequences of last year’s energy crisis.
Megatrends are demographic, ecological and economic structural developments, as well as social and technological ones, that are helping create enduring change in the world.
We strive to understand these megatrends and aim to translate them into tangible investable themes.
Defining investment themes: Boom or bust?
A deep understanding of how megatrends are impacting the long-term prospects of the industries concerned is required to translate them into tangible investment themes.
Ultimately, the goal is to discover industries whose businesses are set to experience an extended boom while also avoiding those that are adversely affected.
The booming industries should grow structurally, meaning that their growth should go beyond the business cycle, both in terms of dynamics and duration.
The key elements we keep an eye on are high entry barriers within each industry, as this protects the position and profitability of established players, and competitive forces that are developing due to the expected structural change.
Sticking with the example of energy transition, the key question is how established players in the power market or the automotive industry react to the developing “new world” and its new set of rules.
How are utilities adapting to the growth of renewables? What does the electrification of our cars mean for the existing value chains in the automotive industry? Which companies will drive the new industry cycle?
While these are the key longer-term questions, not only do changing market structures and market forces matter, both nationally and internationally, but so do companies, which always move with the business cycle.
These companies also often face government interventions that either influence structural change, accelerate it or even slow it down.
Historically, such interventions have sometimes led to the overstimulation of an industry, followed by a shake-out. A very prominent example of this is clean energy from 2012 to 2016.
Analysing companies: Leader or laggard?
Once we have identified an investment theme, we determine which companies are in a position to profit from the expected structural changes.
We also look at which companies will suffer from these trends because their business models are not suited to keep pace with the changes.
Simply put, the task is to understand the comparative advantages and disadvantages of each industry and to separate the likely winners from the likely losers of structural change.
To achieve that, you require a thorough understanding of a theme’s value chain, the strengths and weaknesses of the companies involved, and the related opportunities and threats that are looming.
Furthermore, a comprehensive toolkit is needed to analyse the economic and financial consequences for the companies in focus.
Seizing the investment opportunity: Bull or bear?
While the assessment helps us to build the basis for thematic portfolios by separating leaders from laggards, further analysis must be done when it comes to the actual investment opportunity.
As always, when investing in equity markets, it is important to compare one’s own growth expectations with those of the market – especially in phases of euphoria – as market participants tend to overestimate the short-term growth potential.
This is especially true for rather narrow themes characterised by only a small number of thematic market leaders, such as rare earth elements (2011) or hydrogen (2021).
If this comparison of one’s own expectations with the market’s expectations leads to the realisation that the latter is too optimistic, then it does not seem advisable to chase the market.
In such a situation, it makes much more sense to forego a theme or parts of it. After all, even thematic investing is tactical investing.
When it comes to thematic investments, investors should also refrain from focusing on only a small number of companies as the forecasting horizon is long and cluttered with uncertainty.
Instead, they should take a diversified investment approach along the entire value chain that the investment theme represents.
In the case of clean energy, this includes modules and systems, wind equipment, solar materials, and energy storage, as well as power producers and distributors.
While last year was challenging for thematic investments, since they suffered quite strongly due to their growth bias, it is important not to lose sight of the strength of the underlying megatrends.
In that sense, we consider 2022 as a year when long-term growth estimates were repriced, but not one where long-term structural trends were reassessed, because one thing is for sure: the only constant is change.
Carsten Menke is head of next generation research at Julius Baer