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What is Thematic Investing & How it Works
With the evolution of the capital markets, new ideas and strategies are reaching Indian shores. The acceptance of fresh ideas leads to the emergence of new investment strategies, which eventually result in new financial products. The latest idea to gain traction in investing circles is thematic investing.
What is thematic investing?
Our lives are guided by our understanding of the world around us. Similarly, it is easier to commit money to something that one understands. Thematic investing is a top-down investment philosophy that uses broad macroeconomic trends to analyze investment options. It seeks to align investment decisions with noticeable social, corporate, or economic trends. The decision-making framework in thematic investing is based on ideas rather than facts alone. In traditional investing, fund managers select securities or assets based on their performance relative to the sector or the broader index.
On the contrary, thematic investing seeks to gain from the growth of companies or assets that have the potential to be direct or indirect beneficiaries of a broader trend. For instance, environmental sustainability is widely recognized as a popular trend. Governments world over are pushing for the adoption of cleaner technologies and regulating polluting industries. To gain from the trend, a fund manager may invest in a variety of companies spanning across traditional sectors. He/she may distribute the corpus across renewable power companies and electric car manufacturers.
How is a thematic investment created?
Thematic investing sounds simple, but the simplest of things require planning and a systematic approach to imitate at a large level. To create a thematic investment, fund managers choose a theme or trend expected to gain prominence in the future. Trends can be recognized by studying developments in society, technology, economics, or specific regions. For example, digitization of the economy can be considered to be a recognizable trend in India.
After zeroing on a trend, fund managers analyze if the trend is short-term, structural, or speculative and how any changes in the trend will impact other sectors and regions.
Once the nature of the trend or theme is finalized, the fund manager identifies companies or exchange-traded funds with direct or indirect exposure to the trend through industries, customers, product line, services, business model, or demographics. If we consider digitization to be a trend, companies like Reliance Industries and Airtel can be said to be the direct beneficiaries. Additionally, listed companies that produce content for digital media can be considered to be indirect beneficiaries of the trend.
The fund manager narrows down the list by analyzing companies likely to gain from the trend on various parameters like liquidity, risk, performance, quality of management, earnings estimate, etc. After a thorough analysis, the fund manager is left with the strongest stocks that are likely to gain from the trend.
Benefits of thematic investing
Thematic investing is a marked departure from traditional investing strategies like relative investing. It offers a wide variety of benefits to investors.
Intuitive investing: Thematic investing is based on the intuition and ideas of the investor. In thematic investing, you invest in companies and trends that resonate with you. You follow an idea for a long time when it excites you. Following a trend for a long time provides one an in-depth knowledge of the idea. Better knowledge gives you an edge and unique insights, which is likely to lead to smart investment decisions. Having a prior interest in a trend makes it easier to conduct thorough research which helps you customize your portfolio.
Investments aligned with values: One of the major benefits of thematic investing is that you can align your investments with your values. For instance, even if you are against animal cruelty, you invest directly or indirectly have to invest in livestock companies if they fit the parameters of traditional investing. In the case of thematic investing, the investments are more aligned towards your values as you choose the trends that you are passionate about.
Adequate diversification: Thematic investing strategies distribute the funds across companies and sectors ensuring adequate diversification. The portfolio contains various companies likely to benefit from a chosen theme. Other investment options like mutual funds also diversify the investment, but thematic investing offers adequate diversification. Mutual funds over diversify, which suppresses the returns, but thematic investments stick to a handful of companies based on a specific trend.
Thematic investing in India has been gaining popularity as it is easier to understand and simpler to execute. Thematic investing also ensures that you invest in the future rather than the past. A concentrated focus on a recognizable trend leads to higher returns. However, it is important to conduct thorough research to finalize the theme as an incorrect presumption can lead to undesirable results.
A Quick Recap
- Thematic investing is a top-down investment philosophy that uses broad macroeconomic trends to analyze investment options.
- Thematic investing seeks to gain from the growth of companies or assets that have the potential to be direct or indirect beneficiaries of a broader trend.