WisdomTree’s head of research for Europe, Chris Gannatti, writes about thematic trends and the changing face of technology investment.
Since the Global Financial Crisis of 2008-09, companies in the information technology sector have driven global equity markets to record highs. Investors are looking to evolve their exposures for the future, cognizant of how concentrated certain benchmarks have become in some of the world’s largest companies by market capitalisation.
The primary benefit of highly focused, ‘thematic’ equity exposures is that it allows investors to connect with emerging stories across technology as opposed to simply allocating more to the likes of Facebook, Amazon, Alphabet, Apple, Microsoft and other giants.
Thematic approaches to equity markets are not new, and actively managed strategies have existed in Europe going back to the early 2000’s. Initially, the concept was that either active managers would move around across different themes when they were viewed to be attractive, or they would maintain exposure to multiple themes simultaneously.
The proliferation of exchange-traded fund (ETF) options that began around 2015 has been transformative to the market in that currently we feel that there are nearly limitless thematic options available.
By separating the broad universe of thematic strategies into categories allows us to think more clearly about these portfolio building blocks in a more useful context. We have identified four broad groupings ‘demographics and social shifts’, ‘technological shifts’, ‘geopolitical shifts’, and ‘environmental pressures.’
The reason that groups are important regards how one might think of ‘risk’ for a coming period. It would be difficult for all four groupings to perform with equal strength in any given period, and it’s more likely that market conditions might favour, for example, those strategies delivering on ‘technological shifts.’ A future period might end up as more favourable to ‘demographics and social shifts’, for example.
To us, a portfolio of solely different ‘tech-focused’ thematic strategies may not be as resilient to changing market conditions as a portfolio that seeks to diversify across technology and at least some of these other groupings.
Even within our ‘technological shifts’ broad category, a few levels down investors might choose to focus on topics like ‘cloud computing’, ‘artificial intelligence’, ‘cybersecurity’, ‘nanotechnology’, etc. Having these groupings will help people put 2020 into context.
During 2020, cloud computing represented a group of companies that provided extremely helpful solutions for the needs of businesses and consumers during the Covid-19 lockdowns. Very strong performance certainly reflected this.
We have spent the first quarter of 2021 recognising that volatility in cloud computing strategies may increase in the near term, but the main focus must remain on the fact that the vast majority of business software could be cloud-based by 2030, and the size of this pie today is around $4 trillion (€3.34 trillion).
For those thinking less about the long-term and more opportunistically in 2021, maybe their focus would go towards a variant of Artificial Intelligence with large exposure to semiconductors, since it’s very clear that many industries need semiconductors and there have even been shortages so far in 2021.
Cybersecurity has become a very interesting topic in a world of remote work, and even if share price performance can ebb and flow, demand for these services should steadily increase.
Wherever an investor might focus within the thematic universe of equity strategies, it is critical that they are always looking under the hood at both the methodology and components. These strategies may claim to be in the same ‘theme’ or have the same words in the strategy name, but further examination would tend to find very different exposures and underlying companies.
We believe in expert-driven selection models where each underlying constituent has a direct connection to the over-arching theme. In certain cases, this may lead to a shorter, more concentrated list of companies, and in other cases, depending on the theme, it may lead to a longer list of companies with varying exposures to the theme’s ‘value-chain.’
With thematic strategies, there isn’t a ‘correct’ or an ‘incorrect’ and no one knows what levels of performance will be generated ahead of time, so it is even more critical to ensure that the methodology and exposure of the strategy fits with the investor’s beliefs and aligns within their portfolio context. Approaches that allow exposure to evolve with the theme could have even greater impact.
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