The Covid-19 pandemic has wreaked havoc across many sectors, but it has also led to an acceleration in long-term mega trends linked to technological, demographic and environmental change.

It’s no wonder then that investors are putting their money where their mouth is, with flows into thematic funds seeing year-on-year growth of 58% between 2019 and 2020.
We have seen a steady increase in allocations to thematic funds over 2020. Thematic funds are now seen as part of a fully-fledged long-term allocation that can help decouple portfolios from short-term market trends.

~ Julien Dauchez

Pandemic accelerates shifts towards mega trends
As a result of the pandemic, we are all communicating, working and consuming more online and investors are looking to have exposure to both the real economy and the more digital world we now live in. Resource scarcity, innovation and demographics are all long-term considerations for investors.

The focus on renewable energy from both the incoming Biden administration and the European Union is likely to increase demand for these sectors. Indeed, the EU has agreed on a 7-year budget including multiple green initiatives, and President Biden is planning on a massive infrastructure package that will focus on renewables.

From an investor perspective, demand for ESG-driven strategies has risen and is only set to increase further. Responsible investing is gathering steam as regulatory moves in Europe push for better ESG rating across the asset management industry. Investor appetite is also growing in Asia as China seeks to improve its climate. The US remains a laggard, but the events of 2020 accelerated the move in that direction.

Moreover, ESG-related strategies proved defensive in the market turmoil of March 2020, showing that ESG was not just a smart investment choice over the longer term on a risk-adjusted basis, but also resilient through short-term bouts of volatility1.

Investors no longer need to choose between performance and ethical investing. As a result, ESG has become a must-have rather than a nice-to-have.

Put your money where your mouth is
Flows into thematic funds have seen year-on-year growth of 44% and 58% over the last few years, despite their presence in a universe that has seen outflows from actively managed funds.

Flows into ESG strategies have seen similar growth patterns, but the pre-existing asset base was already much larger, with inflows nearly reaching $1 trillion USD in actively-managed ESG funds.

Translated into portfolios, we have seen a steady increase in allocations to thematic funds over 2020.

Taking French portfolios as an example (confirmed by anecdotal evidence elsewhere), thematic funds are now seen as part of a full-fledged long-term allocation that can decouple from short-term market trends as they target areas like the silver economy2, green cities, safety & AI and water security.

This has only been further supported by the resistance of these strategies during last year’s shock and their stronger rebound.

(Note that the mechanical price effect explains part of the rise of these funds in the typical portfolio allocations).

One consideration is that there is still a fine line between ‘sector funds’ and ‘thematic funds’. For example, financial advisors often use technology funds to build ‘future-proof’ allocations, but we believe the universe is much broader than one sector. As for ESG strategies, they confirm their prime position in portfolios, becoming the new norm.

Future asset allocation changes favour Thematic Equity & ESG Funds

Thematic strategies complement portfolios
When breaking down a number of mega trends to see their impact on portfolios, it is clear that they can help improve Sharpe ratios and overall portfolio diversification.

Mega trend Sharpe Ratios compare favourably with other portfolio allocations

Dial up or down the cyclicality
From an investment perspective, mega trend investing offers a few clear advantages.

First, the investment universe is clearly defined and the factor exposure is purer. Investors find that they can easily relate to the underlying themes and understand their structural growth story, in addition to investing in an innovation cycle.

Another advantage of mega trends is the scarcity of supply: a lot of money behind a small number of opportunities and/or a limited addressable investment universe, which can further amplify the relative outperformance of these strategies.

In addition, in an environment where interest rates continue to be lower for longer, investing in secular growth trends offer some reassurance of sustainable growth. This also suggests that the timing matters less, since thematic and environmental considerations are multi-year drivers.

Finally, different themes have different characteristics. Within mega trend investing, investors can ‘dial up’ (or down) cyclicality. For example, automation and robotics might prove more cyclically tilted, while environmental considerations will prove more defensive and ‘cycle-proof’.

2 Silver economy is the system of production, distribution and consumption of goods and services aimed at using the purchasing potential of older and ageing people and satisfying their consumption, living and health needs.

Related Articles

David Herro on Value Catalysts in Global Markets

Why rising interest rates and a prolonged global recovery should propel value stocks is explained by Harris Associates PM David Herro.

ESG - Transition your portfolio for tomorrow's world

Amber Fairbanks, Portfolio Manager CFA® at Mirova US, talks to Citywire about their Global Sustainable Equity strategy and what sustainable investing means to them.

Alpha Thesis Behind Loomis Sayles’ Growth Equity Strategies

A deeply held system of persistent beliefs, a rigorous investment process, and proof points of Loomis Sayles’ Growth Equity alpha thesis are explained.

Wellness, Now More Than Ever

Wellness has become a daily concern. To preserve their health capital throughout their lives, individuals are investing more in their physical and mental wellness.

  • September 28, 2021