What caught my eye?v.59In praise of Thematics

In this latest issue, we discuss importance of Thematics in structuring portfolios and how it could add uncorrelated returns that are independent of Central Banks.

Over the last three years we have been arguing that pure Thematics are likely to become an increasingly important part of investment landscape. Whilst equity investors have in the past been reluctant to embrace Thematics, or at least regarded them as separate from traditional strategies, we believe investors are on the cusp of a significant change, with Thematics playing a far greater role.

There are two forces driving investors towards Thematics. First, realization that there are powerful structural changes at play altering the key fundamental assumptions underlying the global economy, key sectoral or stock fundamental drivers. Second, in an environment dominated by the public sector and central banks (CBs), there are few opportunities for investment styles that are uncorrelated to macro cross-currents, with Thematics being the prime example.

However, we believe that it is critical to identify the right themes. In the last twenty years, investors were looking for positive themes, such as emerging markets; convergence and hence rising consumption and middle class creation; generic technology; environmental and conventional demographic themes. We believe that the next ten years would be time for negative (constraints based) themes. Investors are likely to inhabit an investment world characterized by divergence not convergence and declining returns on humans, which is likely to turn demographic dividends into curses, preventing and reversing middle class creation while strengthening de-globalization. Also as technologies mature, we believe that generic technology themes would outlive their usefulness.

We maintain that ‘declining returns on humans’ is the strongest and most persistent theme shaping most investment strategies. It is driven by fundamental forces that are altering manufacturing and production value chains; provision of services and the role that people play in various stages of production or trade. These forces are destroying conventional perception of labour markets and they question the value and importance of human inputs. We usually describe it as the ‘Third Industrial Revolution’ but other investors prefer descriptions as diverse as ‘robotics and machine age’ to ‘buy robots and sell humans’ era. We prefer ‘Third Industrial revolution’, which indicates we transited through similar (though nowhere near as disruptive) periods at least twice before.

As with the First (1750s-1850s) and Second (1880s-1940s), the Third Industrial revolution (from 1970s) is redefining relationship between people, machines and societies. Whilst ultimately boosting productivity, each revolution tended to be highly disruptive and current is no different. In the midst of transition, productivity & real incomes tend to stagnate whilst income/wealth inequalities rise both within and between countries, with obvious social and geopolitical consequences. The latest phase is further aggravated by three decades of overleveraging (a by-product of contemporary societal response to stagnant productivity & incomes).

Building on prior work (here and here) we identify seven global themes that benefit from declining ‘return on humans’: human replacement (robotics, automation & AI); human augmentation (biotech); social upheaval (‘prisons & bullets’); ‘opium of the people’ (games; 3D; entertainment); education & skilling; demographics and ‘disrupters & facilitators’. There are other themes that we eventually plan to add (e.g. impact of minimum income guarantees) which are not yet mature. We constructed a global portfolio that reflects these themes, complementing our narrower Asia ex ‘Thematic winners’ portfolio.