Thematic investing focuses on emerging trends that could disrupt the current market landscape for many years. Typically, thematic investment opportunities occur early in a new product’s or technology’s life cycle, where growth is at or close to its highest trajectory. Thematic investments often originate from technological advancements, trends in populations, shifting consumer preferences, or changes to regional economies.
However a theme emerges, it often represents a long-term and fundamental shift, powerful enough to affect market performance across multiple industries and geographies.
-John Ravalli, Managing Director of Portfolio Strategy, Hawthorn
The Diffusion of Innovation Theory, developed by E.M. Rogers in 1962, has been widely adopted in describing how disruptive technologies often follow an adoption curve with five distinct stages (Chart 1). We find this theory to be particularly useful in framing how we differentiate thematic and traditional asset allocations. For example, a mature company focused on producing consistent results and returning capital to its investors likely sits in the “late majority” or “laggards” stage. On the other hand, a social media company reinvesting all of its earnings into its business would likely be in the “early adopters” stage.
Most traditional asset allocation methodologies are bound by typical index construction conventions related to factors such as market capitalization, sector, industry, region, and style. Market capitalization indexes are, by their nature, backward looking, assigning a higher weight to larger companies. This often results in a systematic underexposure to emerging trends that could disrupt the current market landscape for many years. We believe thematic investment strategies offer a solution to this pervasive asset allocation shortcoming. Ravalli says,
We have identified several thematic investing themes with the potential to disrupt existing market dynamics and/or create economic paradigm shifts: lithium-ion battery technology, financial technology (fintech), artificial intelligence (AI)/robotics, water resources, social media, and Internet of Things (IoT).
We’ve developed Thematic Investing at Hawthorn series of papers to support our thematic investing initiative. By allowing for such investment opportunities, our goal is to create a unique source of return within our overall asset allocation that relies on deep fundamental research, a multiyear view, and careful execution.
Characteristics of Six Themes
Each of the thematic investing themes has several defining characteristics and benefits. Lithium’s light weight, high energy density, and rechargeable properties make it an attractive energy source for many products such as smartphones and laptops. Until recently, its high production costs have limited its applications. But technological advances have found their way into the lithium battery value chain, driving down production costs and improving efficiency.
FinTech’s impact is felt beyond just financial services. What started in the 1950s with credit cards and followed by a series of developments, including e-commerce in the 1990s, fintech is evolving at a breakneck pace. We believe advances in this field could lead future generations of growth across capital markets.
The challenges confronting water resources and its associated infrastructure present a compelling thematic investment opportunity, with water shortages in the coming decades expected to boost prices for this commodity. Companies actively involved in the water industry may stand to benefit over the longer term.
Joining the disciplines of AI and robotics can create intelligent robots with a range of implications. As computers have become more powerful and data more readily available, advances in AI and machine learning have followed. We believe the combination of these disciplines with robotics can have a significant economic- and business-related benefit.
Many businesses rely on social media not just to market their products but also to gain a better understanding of how their brands connect with their target audience. Those companies on the forefront of capturing and monetizing the information collected on social networks may have the potential to profit over the longer term as marketing strategies adapt with the times.
The emerging technology of IoT may be in the early stages of development, but the number of potential applications is significant. More companies worldwide will likely migrate toward implementing smart device sensor technology in their everyday operations and long-term strategic plans, making investment in powerful analytic technologies a potential growth opportunity for investors.
Our thematic investment strategy attempts to identify themes that we believe have the potential to drive structural change. In these papers, we have outlined our initial six thematic allocations. We will continue to explore emerging opportunities that align with our investment process.
If you are interested in learning more about our thematic investing strategy, please contact a Hawthorn Investment Advisor.