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The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
The elevated economic and market volatility witnessed in 2022 isn’t likely to abate when we turn over the calendar to a new year. With the return of inflation, central banks can no longer afford the endlessly loose monetary policy that served to mute the effects of the economic cycle in the post-GFC period. In fact, as our macro strategist team has argued, central banks will struggle at times to find the right balance between tamping down inflation and propping up growth, and so it seems reasonable to expect a more traditional cycle with distinct and potentially more frequent moves from one phase to the next.
In this new, more volatile regime, we see a case for thematic allocations focused on long-term structural trends. Specifically, we find evidence that thematic investing may help reduce the importance of the economic cycle to portfolio returns.
For context, we define thematic investing as the identification and exploitation of a top-down, innovative, or disruptive trend that has a structural tailwind with the potential to drive above-average returns for companies participating in that theme. Returns to themes cannot be easily explained by traditional country, sector, or style factors.
While thematic investing can be applied to different asset classes, it is often expressed via equities, which is where we have focused our research. Examples of equity themes include fintech, the future of education, energy efficiency and automation. By investing in companies within these themes, investors are assuming that their growth potential is not yet fully appreciated by the market — but will be over time.
If thematic investments generate their returns by exploiting structural change, then including them in a portfolio could make the difficult task of timing the cycle less important, reducing the reliance on strong economic growth to drive strong returns. Thematic allocations could also help increase diversification given how much cyclical exposure is typically found in a portfolio.
To test this argument, we compared the cyclicality of global equity sectors and global equity themes. We used a large universe of single-theme managers, based on thematic mapping work by Broadridge, a data provider that collects and reports AUM and flow data on more than $42 trillion in global fund assets. We defined cyclicality based on the correlation with the OECD’s US cyclical leading indicator (CLI). As indicated by the dashed black lines in Figure 1, we found that themes were, on average, about half as sensitive to the cycle as sectors.
The primary reason themes could make shorter-term cycles less important is that they inherently focus on forward-looking structural change and the companies that may be exposed to it. Many traditional equity allocations, on the other hand, are constructed and sized on the basis of market capitalization, which tends to be backward-looking in nature as it overweights past winners.
One of the forward-looking structural trends that we see emerging at the moment is financial inclusion — the global push to ensure that individuals have access to useful and affordable financial products and services. Our team recently published an article on the topic, which can be found here.
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