Thematic investments have tripled as a percentage of global equity fund assets over the past 10 years, now representing 2.9%, according to Morningstar. It’s only been two years since we last examined whether these investment themes can be used for setting asset allocation, but in this time the world has changed quite significantly.
Instead of long-term low interest rates, we now have stubbornly higher inflation, accompanied by higher interest rates to combat it.
So the question we ask now is: has enough changed to alter our view about using themes in setting asset allocation?
And what about the other themes we identified in a paper back in 2019 titled Inescapable Truths for the decade ahead? Are they still relevant?
We believe the original themes of Demographics/technological innovation and Decarbonisation will continue to persist. In addition, post-Covid, our research has identified a further ‘D’ to add to this list of themes: Deglobalisation.
In this paper, we examine these 3Ds and discuss what a portfolio with structural thematic allocations can possibly look like. We focused on public assets rather than private equity here.
The questions we tackle include:
- What makes a good theme for SAA?
- How do we invest in the 3Ds?
- How have the 3D themes held up against the broader market?
- Should we build portfolios just using the 3Ds?
In summary, here are our findings:
- Thematic equities should be used in conjunction with traditional allocation vectors, rather than replacing them entirely.
- Careful consideration should be given to how themes cluster with regional and sectoral equity indices – they often intertwine.
- Thematic ideas can overlap in terms of risk exposure, so it's essential to evaluate how to access the themes and adjust the existing portfolio to ensure that risks are being taken as intended.
- It is crucial to exercise caution when selecting themes and to organise portfolio construction in a balanced manner, either through a core satellite or carve-out approach. Passive instruments may also not grant the investor the full intended exposure to each theme and may expose them to additional risks.
- Thematic investing in relation to asset allocation focuses on taking advantage of enduring and fundamental changes in the market, rather than temporary and periodic fluctuations.
- A prolonged investment horizon is required for thematic investing, and investors should not anticipate immediate or short-term rewards.