Using trusts to invest in themes

Why themes?

Thematic investing is often considered a mixed blessing because novice investors can fall prey to slick marketing and popular fads that prove anything but durable, and therefore turn out to be costly – often the ‘popularity’ is already reflected in share prices. Too often, funds are launched that capture the mood of the moment, but then wither on the vine. There can be no substitute for fundamental research whenit comes to the resilience of the trends in question, and there also needs to be a clear commitment to then stay the course given the path is rarely a smooth one.

Both the problem and perception have been compounded by the explosive growth in the number and scope of thematic exchange traded funds (ETFs), which can often be blunt instruments when seeking to capture certain themes. Often large companies are held because of their marketability, given the liquidity requirements of ETFs. These companies can appear to tick a box but, on closer examination, because of their other component businesses, are often far from being a pure play on the theme in question.

Meanwhile, other ETFs can distort markets by taking large stakes in smaller companies, or not accurately reflect the chosen sector due to complexities – the myriad of crossholdings within the commodity sector, which are hard to replicate particularly when it comes to small and medium-sized enterprises (SMEs), being one example where ETFs struggle. This is not to say thematic ETFs should be shunned completely but, as ever, careful selection remains of paramount importance.

Such pitfalls should not blind investors to the generous returns to be harvested from pursuing the right themes. Portfolio returns by region or geography tend to be more correlated to the relationship between macroeconomic performance and market valuations. Such factors are less influential in deciding the returns from thematic investing and so can offer an element of diversification as well as better performance.

Despite the immediate outlook for globalisation, the world is becoming more transparent and connected despite some governments’ best efforts. Thematic investing allows investors to embrace a broader perspective given the investment opportunities across global equity markets – profitable opportunities that transcend portfolio allocations based purely on geography. And the importance of perspective to good fund management should not be underestimated – very often the big picture aids stock selection.

Portfolio managers are recognising the potential. At an important seminar on thematic investing in 2019, BlackRock highlighted various long-term global trends that are encouraging structural shifts in many sectors and industries – and these, in turn, are influencing the trajectory of corporate earnings. As Alistair Bishop, managing director, put it: “These forces, which we call megatrends, are giving rise to a new set of powerful investment themes – the advent of disruptive technologies, radical shifts in consumer choices, greater regulatory intervention, and new opportunities for growth.”

BlackRock focused on five megatrends: rapid urbanisation; climate change and resource scarcity; demographics and social change; the changing economic power of emerging markets; and disruptive technologies. The company believes the most powerful investment themes will be the result of a confluence of at least two of these megatrends. And because of their nature, long-term horizons will be required. Investors will need to be aware of the life cycles of themes and possess the patience to fully harness the returns.

Alistair continued: “Themes have longevity because the key megatrends that underpin them tend to persist for a long time. However, across this extended timespan, themes evolve and change shape. Themes overcome hurdles and gain momentum. Themes can be accelerated by innovation but constrained by consumer inertia. Themes can be reinforced by corporate investments but hindered by regulatory uncertainty. Thematic investing is non-linear.” It is the long-term compounding effect of share prices that really matters.

Favoured themes

Since their inception, the two portfolios covered in this column, and the other eight real investment trust portfolios managed on the website www.johnbaronportfolios.co.uk in real time, have maintained meaningful exposure to various themes – and these have contributed to good outperformance of respective benchmarks. Indeed, many of the portfolios have greater exposure to themes than the category of ‘international shares’. The key trends pursued are smaller technology companies, and the full spectrum of opportunities within the healthcare, private equity and climate change spaces.

The very nature of the latest technology revolution – the internet and, with it, digital transformation and adoption of more technology-enhanced business models, means the sector will continue to benefit somewhat from its own multi-year cycle. Smaller companies are preferred in part because of the valuations of their larger brethren, despite their recent correction, and regulatory concerns. Portfolio holdings include Herald (HRI) and Augmentum Fintech (AUGM) – the latter in particular is standing on an attractive discount.

Ageing demographics, a more favourable regulatory environment and the emergence of an affluent middle-class coupled with urbanisation in many emerging markets are some of the reasons to be positive about healthcare. Scientific innovation is a further factor – the DNA discoveries of Watson and Crick in 1953, the sequencing of the human genome, and the falling cost yet increased power of computer technology are continuing to transform the landscape. Holdings include Bellevue Healthcare Trust (BBH) and Worldwide Healthcare Trust (WWH).

In addition to my website’s dedicated Green and Green Isa portfolios, another prominent theme pursued by the portfolios is that of combatting climate change and protecting the environment. Holdings in this sector can be used to help diversify portfolios – these being typically infrastructure companies that provide exposure to a range of renewable energy sources, while providing handsome yields. The theme is also pursued via companies that invest in businesses with eco-friendly products and services. Holdings in this latter category include Impax Environmental Markets (IEM) and Jupiter Green (JGC).

The case for private equity is particularly attractive at present given the discounts on offer. The gradual de-equitisation of markets, together with the quality and track record of the private equity managers, suggest good asset performance will continue. Some of these companies focus on the secular growth themes mentioned above, and more. Holdings include Aberdeen Private Equity Opportunities (APEO), Pantheon International (PIN), HarbourVest Global Private Equity (HVPE), Apax Global Alpha Ltd (APAX) and CT Private Equity (CTPE) – the latter two providing attractive dividends based on their net asset values (NAVs).

Some of the themes pursued by the portfolios do indeed represent a confluence of at least two of the megatrends highlighted by BlackRock. For example, the healthcare sector will continue to benefit at least in part from disruptive technologies, ageing demographics and social change, as well as perhaps from the changing economic power of the emerging markets.

Meanwhile, mention has been made of the importance of maintaining portfolio balance relative to remit. While the portfolios have long pursued thematic investing, this needs to be balanced against a portfolio’s regional and geographic exposure given the greater the weighting to growth themes within the equity exposure, the higher the risk and therefore scope for returns (and losses).

Such considerations are important when considering the remit of a portfolio. That said, as an indication of the potential returns to be had from thematic investing, my website’s Thematic portfolio brings these and other themes together, as well as providing exposure to special situations. While never complacent, this portfolio has returned 137.4 per cent since its inception in 2014 to 31 January 2023, which compares well with relevant benchmarks.

Future columns will examine these and other themes in more detail.