The Evolving Economy

How can investors choose the right long-term investment themes?

With the pace of technological and demographical changes seemingly moving faster than ever, investors are inundated with new ideas of what the next big investment trend will be.

We’re often asked about new, emerging, or high-profile investment opportunities, and whether they warrant a dedicated investment portfolio. While themes like the sharing economy or electric vehicles are interesting and have certain investment merits, they may not be suitable to construct a dedicated portfolio around.

Discover the three key criteria we use to help our investors look past the headlines to the long-term investment reality when selecting an investment theme:

  1. Growth themes must be investable and long-term
  2. Themes must have a certain level of ‘purity’
  3. Must be a true opportunity for active management

1. Growth themes must be investable and long-term

When identifying long-term growth themes, we need to see evidence from relevant and credible sources that the theme has the potential to deliver approximately 10% or more year-on-year growth over the next decade1. We also look to ensure that a theme has an expanding investment universe in listed equities with sufficient diversification across regions, sectors and market cap.

This issue of investability is particularly relevant to investors seeking exposure to the ‘sharing economy’ of companies like Airbnb or Uber. While these businesses have revolutionised the ways in which today’s connected consumers access goods and services, many remain privately owned and thus inaccessible to most public investors. And when or if they issue an initial public offering (IPO), we would typically wait for hard evidence of the company’s commercial viability and results as a listed company before investing.

It’s not just where you invest – it’s how

Even when an area seems investable, ensuring that portfolios are suitably diversified to mitigate potential volatility or cyclicality is essential. For example:

Sustainable transport. Electric vehicles and ‘smart mobility’ technologies offer an interesting field of opportunities. However, we believe it is best to access the growth of this area as a sub-theme of our broader ‘Clean Economy’ strategy rather than as a dedicated sustainable transport portfolio, to mitigate the area’s small investable universe and high correlation with the automotive industry.

Food and water. Similarly, the theme of addressing natural resource scarcity is a particularly compelling one as investors seek to allocate their capital to more impact-focussed outcomes. However, the investable universe remains concentrated, so we prefer to incorporate ‘responsible nutrition’ as one sub-theme of our broader ‘Clean Economy’ strategy to ensure that we can be selective and invest only where we see companies with compelling fundamentals.

Regtech. Elsewhere, regtech (regulatory technology) is becoming increasingly important as financial services companies face mounting regulatory challenges. However, the investable universe remains small, and we prefer to access the area’s best-in-class opportunities through our more broadly diversified fintech strategy.

2. Themes must have a certain level of ‘purity’

The second aspects of our approach to thematic investing is defining companies’ level of exposure (or ‘purity’) to a particular theme, to truly understand what is driving or supporting long-term growth.

Using a combination of fundamental analysis, sell-side thematic exposure data and the FactSet Revere revenue exposure tool, our investment team has developed a proprietary thematic exposure database of over 11,000 stocks2 which help us to classify growth companies according to their current and future level of exposure to a theme:

  • High exposure

    > 50% of company revenues from the theme (generally small caps)

  • Medium exposure

    10-50% of company revenues from the theme (generally mid and large caps)

  • Low exposure

    <10% of company revenues from the theme (generally mega caps)

Typically, at least 70% of the holdings in our thematic portfolios are companies with high and medium exposure to a theme – and this figure currently averages around 90% across our range of thematic funds2. Returning to our earlier regtech example, the investment universe of companies that currently have a high or medium exposure to this area isn’t very large, and the companies within that universe can have a high degree of correlation – we thus prefer creating a high purity of exposure to the broader fintech theme across a wider and richer investment universe.

3. Opportunity for active management

Understanding the difference between short-term hype and longer-term commercial reality, and who the likely winners and losers within a theme will be, are crucial for investors looking for sustainable performance.

We believe that active management plays a crucial role in adding value when investing in such long-term thematic opportunities. Accordingly, our team seeks to identify the companies that are best placed to benefit from the themes, rather than just investing in a basket of stocks exposed to the theme. The corporate sector in disruptive change is dynamic and it is critical to identify the individual long-term winners, as there are losers even in areas of high structural growth.

We also believe that launching a portfolio in a new theme can be only done if most of the universe is already suitably covered by our regional, thematic and sector fund managers within Framlington Equities. This is particularly true in the small and mid-cap area as this has historically been a rich source of opportunity and added value within our portfolios.

The investable opportunities of the Evolving Economy

So, while investors will continue to search for the elusive ‘next big thing’, we believe in looking most closely at the investable reality. In our view, these three main criteria we use when considering launching a thematic investment strategy, will hold us in good stead to capitalise on long-term growth over the coming decades.

Discover the Evolving Economy – A fresh approach to equity investing

1. All figures quoted are from AXA IM, correct as at 18 March 2019. Growth targets are internal, for illustrative purposes only, and are not guaranteed. All investment involves risks, including the loss of capital.

2. Source: AXA IM as at 18 March 2019.

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