Nick Samouilhan, Multi-Asset Fund Manager at Aviva Investors, says thematic investing adds a new dimension to portfolio design
By and large, most multi-asset portfolios are constructed through the complex interaction of three independent investment processes. The first determines what to hold over the long term, or strategic asset allocation. The second dictates what to hold over the short term, or tactical asset allocation. The third is how to implement the above decisions and is called security selection.
Overall, differences between portfolios are down to how a fund manager blends the above three elements and the idiosyncrasies of their security selection. We believe there’s no single correct solution. The most suitable approach will depend on the client’s mandate and the skills and preferences of the manager.
Adding Value Through Thematic Investing
Once you have incorporated asset allocation (whether strategic or tactical) and security selection it’s time to think about a fourth process, namely thematic investing. Some examples of themes include the growth of a ‘new’ middle class in emerging markets, population growth, natural resources scarcity, renewable energy and climate change.
Thematic investing aims to exploit a global economic trend which can be driven by politics, culture or demographics or a structural change that isn’t otherwise captured. In theory, themes offer portfolios a fourth and independent lever to apply to their portfolios. This can create more investment options and so additional diversification possibilities.
Making the Most of Themes
As with asset allocation and investment selection, the key to successfully implementing themes is a robust process. For thematic investing this can be broken down into three broad steps.
First, the underlying economic trend or structural change that the theme is exploiting must be identified. This driver must usually be structural in nature to stand a good chance of coming to fruition given the broader uncertainty of the investment horizon. Here, economic or demographic changes, given their inbuilt momentum, tend to be the most appropriate structural drivers.
Next, identify clear signposts that can be used to gauge whether the theme is likely to evolve as expected within a two to three year horizon. These signposts help identify whether the theme is coming to fruition or needs to be re-examined. After all, a theme that is not realised within a reasonable horizon isn’t useful in a portfolio context. Even worse, persisting with a theme in the hope that it will one day emerge ties up valuable capital.
Lastly, the theme must be implemented efficiently. Fortunately, this is the easiest part, especially within a multi-asset fund. One way to implement your chosen theme would be to select managers who incorporate it in their normal portfolio.
Unfortunately, this approach could, and likely will, muddle the existing asset-allocation process and there is no guarantee this theme will be kept to fruition in the portfolio.
A preferred approach is to treat the theme as a stand-alone proposition, holding it as a separate position in the portfolio independent of the other three processes. We believe this allows greater visibility of the theme and its performance both in standalone terms and from a portfolio perspective. In our opinion, this approach ensures clarity around the actual theme being implemented.