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Filling the electrification gap
PODCAST – HYDROGEN
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Widespread tech innovation: Don’t miss the forest for the really big tree
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Playing the revolution
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Active vs passive
The best route into thematics
Serious about sustainability
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With thematic funds experiencing significant inflows during the pandemic, could this investment approach become the norm? Where are fund managers and selectors putting their money, and how are risks such as liquidity, stock concentration, and trend chasing being managed?
Where the smart money is going
Thematic winners
WisdomTree’s thematic classification brings order to chaos
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The Green Rush
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THEMATIC INVESTING
Widespread tech innovation
Has thematic investing changed the face of asset allocation?
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Top themes
Fund buyers’ favourite stories
No substitute for active managers when picking thematic winners
by John Schaffer
With traditional portfolio construction techniques, such as the 60:40 split, looking stale, is there a case for investing thematically? Although still a relatively nascent area, assets in thematic funds have more than tripled to $595bn (£422bn) worldwide, up from $174bn three years ago, according to Morningstar. The Covid-19 pandemic has also resulted in huge inflows into thematic strategies, paired with eye-catching returns in certain funds. Is it time for thematic investing to become more of a core focus for asset allocators?
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Speakers featured in this video include:
Joe McDonnell, head of portfolio solutions EMEA, Neuberger Berman Kenneth Lamont, senior research analyst, Morningstar Anu Narula, head of global equities, Mirabaud
Legal & General Investment Management Limited is Authorised and Regulated by the Financial Conduct Authority. The views expressed withing this video are those of Legal & General Investment Management. Past performance is not a guide to future performance. The value of an investment any income taken from it is not guaranteed and can go down as well as up; you may not get back the amount you originally invested. This is not a consumer advertisement. It’s intended for Investment Professionals and should not be relied upon by private investors or any other persons. This video should not be taken as an invitation to deal in Legal & General Investments. Legal & General Investment Management One Coleman Street, London EC2R 5AA Registered in England no 2091894 Source: LGIM unless otherwise stated. ©2021 Legal & General Investment Management. All rights reserved. No part of this video may be reproduced in whole or in part without the prior written consent of Legal & General Investment Management.
HOWIE LI, HEAD OF ETFs AT LGIM
Our job is not to find and pick the winners, because it’s too early for that. Our job is to build a portfolio that gives investors exposure to the growth of a whole new economy
Source: Bloomberg
Source: Morningstar Direct. Manager Research. Data as of December 2020.
Howie, what is LGIM doing to help investors contribute to a greener, healthier world?
CONTENT BY
For Howie Li, the course is clear: we’re on the cusp of stepping into a new economy, based on sustainable development and growth. Legal & General Investment Management’s (LGIM) Head of ETFs discussed the pros and cons of hydrogen, revealed why he’s not that fussed about the big names and explained why electric vehicles aren’t the end of the road.
Unlike other solutions that take an existing portfolio and make it greener by applying various ESG screens or excluding certain sectors, our sustainable ETF range targets companies that are going to contribute toward a green future. Our thematic approach is very different, in that it focuses on areas we expect to have a considerable impact on a sustainable economy. Those include energy storage, clean energy and, more recently, hydrogen.
Hydrogen production accounts for 2.2% of global greenhouse emissions - more than the airline industry. Why does it still play a major role o the way to a more sustainable future?
First and foremost, it’s important to recognise that hydrogen won’t be the sole driver of a clean energy revolution. You’ve got to look at it in combination with more established forms of renewable energy generation like solar panels and wind turbines. Those have a good foundation already, but hydrogen is still at a much earlier stage. It’s true that grey hydrogen isn’t the way forward to build a sustainable society. That’s why we focus on green hydrogen, which comes from renewable energy sources instead of fossil fuels. Electrification through clean energy and battery technology can get us most of the way to net zero, but green hydrogen is the key to lowering emissions in industries where electrification alone is not enough.
How do you go about selecting companies that can advance a green hydrogen economy?
Since the industry is changing so fast, we need to constantly adapt and evolve our classification system. Our job is to find companies that actively invest in this space and contribute to its growth. Those companies may be driving revenue already, but in many cases, they’re still building the foundations of the hydrogen economy. In other words, you can’t just go into Bloomberg or another classification system and say, what does the hydrogen economy look like? Instead, we target the entire value chain. For instance, when it comes to hydrogen generation, we’re looking at companies that provide things like membranes, catalysts or pump compressors. Ultimately, it comes down to utilising global data and working with a range of experts to carve out the universe.
Is that the same approach you take with your clean energy and battery ETFs?
Yes, absolutely. On top of external or proprietary data, we collaborate with dedicated experts who help us understand how those areas are going to develop and grow. And off the back of that, we build our investment strategies. Using clean energy as an example, we look at component suppliers, equipment manufacturers and utilities in the wind and solar power space. Many investors would call that active research. We ultimately end up with a selection of 50-plus stocks, which gives us a pretty focused high-conviction portfolio that is dedicated to investments into clean energy only. Often, you won’t find a lot of those companies in other funds. That’s something we pride ourselves on - finding unique opportunities that have a low overlap with traditional equity portfolios.
What kind of opportunities would they be?
We do invest in companies that more people might have heard of - Vesta, for example – but we also give a near-equal contribution to newer businesses that investors are less aware of. On the topic of clean energy, we’re talking about companies like SolarEdge or TPI Composites. Even though they’re US-based component suppliers, many traditional US equity portfolios don’t hold them. Our job is not to find and pick the winners, because it’s too early for that. Our job is to build a portfolio that gives investors exposure to the growth of a whole new economy. We’ve seen portfolios that focus on the big names everybody knows and probably already hold elsewhere. What that also means, though, is that you’re increasing concentration risks for multi-asset investors.
You’ve made the case for hydrogen and clean energy investments, but what’s the deal with batteries?
It’s all well and good if you can use the energy that’s generated from solar and wind power right away, but what if you can’t distribute it immediately? You need the capacity to store it. The demand for storage solutions has risen sharply over the past few years. The lithium-ion battery segment, for example, has a compound annual growth rate of close to 14%. Even so, the energy storage space is only at the beginning. It needs to catch up with the amount of infrastructure we’ve built to capture solar, wind and, of course, hydrogen power.
In a nutshell, what’s the investment case for storage technologies, then?
The more people utilise alternative energy sources, the more we need to invest in infrastructure that is able to store that energy. Take electric vehicles as an example: the hottest topic isn’t how fast the technology is evolving but how quickly we can get charging points, so electric vehicles become a means of transportation for the masses.
Are there any issues investors should be aware of?
The challenge is the cost of producing those new battery technologies. Even so, it’s worth noting that it has come down over the past few years and will continue to do so as scalability increases. Companies are more innovative in this space, whether it’s Samsung SDI or Tesla. That spells opportunity for investors.
LGIM’s Thematic ETF range incorporates three sustainable energy solutions:
L&G Hydrogen Economy UCITS ETF L&G Clean Energy UCITS ETF L&G Battery Value-Chain UCITS ETF
All of the funds are forward-looking and focus on building a greener economy. As Howie Li put it: ‘If you really want to make a change, you need to invest in sustainable growth themes. Just excluding specific sectors isn’t enough.’
LGIM Wellington Management WisdonTree
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The coronavirus crisis has highlighted how thematic funds dedicated to big concepts such as technology can thrive in the right (or wrong, depending on your perspective) circumstances. But technology is not the only popular theme among investment firms. Across Citywire’s 18 thematic sectors, ecology, infrastructure and healthcare strategies are all well represented (see graph 1) in fund-of-funds, mixed-asset and model portfolios. According to data from Morningstar and Citywire research, the 10 most popular thematic funds among wealth and asset managers drew a total of £8bn in net flows over the past year, accounting for a significant chunk of the £13bn gathered over three years. The Polar Capital Global Technology and the Pictet Global Environmental Opportunities funds alone accounted for more than half the new money among the group over both time periods. Most widely held across all the portfolios in our analysis was the Polar Capital Global Insurance fund, in effect the only way for UK fund buyers to access the market domestically.
We think thematic strategies have a place in client portfolios. They are often managed by experts in a particular sector or area, so they are well placed to take advantage of emerging trends and sectors that are overlooked by the wider investment community because they are hard to analyse. We hold the Polar Capital Global Insurance fund because of the interesting attributes it brings to client portfolios. The strategy is dedicated to the insurance sector and, since inception, has delivered strong compounded returns. The team of Citywire + rated Nick Martin and Dominic Evans find the best quality insurance companies globally, focusing predominantly on those in the non-life insurance industry. The fundamentals for non-life insurance companies tend to be defensive, as insurance is often required by law. This provides a source of demand even through recessions and means the strategy can exhibit a countercyclical profile and behave differently to other funds in portfolios. The team focuses on high-quality specialist insurers with strong underwriting credentials. Because the industry as a whole does not meet its cost of capital, the best underwriters tend to take share from weaker ones. The best underwriters also tend to be compounding machines and deliver steady book value growth.
Alastair Dean, director, Stonehage Fleming Investment Management
AB International Health Care is an active, bottom-up, stockpicking fund, with the manager and analyst team focusing on businesses rather than falling in love with the science. It identifies good fundamental business attributes rather than trying to predict exceptional one-off binary events that occur with low probability – for example, the success with one specific drug. The focus is on an attractive return on invested capital profile and the reinvestment of profits back into each business they own. This philosophy has been developed over a number of years by Citywire + rated manager Vinay Thapar, who has a background in academia but has also spent a considerable amount of time as an analyst and investment manager. Thapar is supported by a six-strong healthcare specialised team and this strong fundamental sector-specific research is a key attraction of the fund. More generally on thematic strategies, it really depends on the theme itself and if this is consistent with our house view, but also the construction of each product and in particular any overexposure to individual stocks.
Duncan Blyth, senior investment manager
by Robin Amos
FP WHEB Sustainability fund
Ninety One Global Environment fund
AB International HC Port
Pictet - Global Environmental Opps
Smth&Wllmsn Snlm Artfcl Intllgnc fund
FP Foresight Global Real Infrs fund
Polar Capital Healthcare Opps fund
Polar Capital Global Technology fund
Legg Mason IF ClearBridge Glb Infras Inc
Polar Capital Global Insurance fund
Sanlam (4)
Casterbridge Wealth (6)
Sanlam (5)
Liontrust (5)
Casterbridge Wealth (3)
Canaccord Genuity (3) Brooks Macdonald (3)
EQ Investors (2) Kingswood (2) Cazenove Capital Schroder & Co (2)
VEHICLE
FIRM
Most held ESG funds
Hawksmoor Investment Management (3)
Threadneedle UK Social Bond
Smth&Wllmsn Snlm Artfcl Intllgnc Fd
FP Foresight Global Real Infras Fd
Polar Capital Global Technology Fund
Polar Capital Healthcare Opps Fund
FP WHEB Sustainability Fund
Ninety One Global Environment Fund
Polar Capital Global Insurance Fund
BMO Edentree Fidelity Natixis
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The chart below shows how many mixed-asset, fund-of-funds and model portfolios hold each of the 10 most widely held thematic funds. A toggle also shows the minimum number of asset management and wealth management firms that own each.
The top thematic sectors in funds of funds, mixed asset and model portfolio vehicles
Source: Citywire/Morningstar
What are some of your favourite thematic funds?
PODCAST: HYDROGEN
Battery technology has been a hot topic in recent years, fuelled by the monumental rise of Tesla and growing concerns over carbon emissions. But lithium-ion batteries are not a good solution for large vehicles such as lorries and aircraft. Can green hydrogen fill the electrification gap? Randeep Somel, manager of the M&G Climate Solutions fund, speaks about the investment case for green hydrogen, the stocks set to benefit from it, and why it is a good solution for current environmental concerns.
Green hydrogen uses renewable energy production. We can see throughout the entire value chain that it is produced on a carbon-neutral basis
Randeep Somel, M&G Climate Solutions fund
For professional/institutional investors only Investing involves risk and an investment may lose value. All investors should consider the risks that may impact their capital, before investing. Concentration risk is the risk of amplified losses that may occur from having a large percentage of your investments in a particular security, issuer, industry, or country. The investments may move in the same direction in reaction to the conditions of the industries, sectors, countries, and regions of investment, and a single security or issuer could have a significant impact on a portfolio’s risk and returns. Investments in emerging and frontier countries may present risks such as changes in currency exchange rates; less-liquid markets and less available information; less government supervision of exchanges, brokers, and issuers; increased social, economic, and political uncertainty; and greater price volatility. This material and its contents are current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management. This material is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase, shares or other securities. Investors should always obtain and read an up-to-date investment services description or prospectus before deciding whether to appoint an investment manager or to invest in a fund. The views expressed are those of the authors as of the date of publication and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients. Wellington Management Europe GmbH, is authorised and regulated by the German Federal Financial Supervisory Authority (BaFin). Registered office: Bockenheimer Landstraße 43-47, 60325 Frankfurt am Main, German. This material is directed at eligible counterparties or professional clients as defined under the German Securities Trading Act ©2021 Wellington Management Company LLP. All rights reserved.
We believe that we are on the cusp of the next big tech wave and, in our view, we’re all poised to benefit. Innovation is constantly improving the lives of people across the globe, transforming our homes, schools, businesses, and daily lives. From digital payments helping to make finance more accessible; to the cloud and the Internet of Things (IoT) boosting efficiency everywhere from farms to factories; to artificial intelligence solving problems from auto safety to disease diagnosis – the world’s progress is grounded in innovation.
Dhananjay Phadnis, Lead Portfolio Manager
From Yash Patodia, portfolio manager; Anita Killian, CFA, portfolio manager; Bruce Glazer, portfolio manager; Michael Masdea, portfolio manager; Brian Barbetta, portfolio manager
Most investors can agree that environmental, social and governance (ESG) factors help determine a company’s prospects for long-term value creation. But how should we quantify the valuation impact of sustainable investing?
A long runway for growth
But the tech sector’s strong recent performance has some investors asking, ‘are we too late?’. In our view, the answer is ‘no’ and the innovation trend continues to offer a long-term secular opportunity. Though areas of the market currently have elevated valuations and the growth curves for some innovations may have accelerated or even plateaued, we think there is still a long runway for growth ahead.
Automation The rise of automation is often thought of in terms of factories replacing workers with more productive robots. After all, the world is not growing as fast as it once was – and we need innovation to offset the slowdown. But the opportunity this technology offers stretches far beyond factories and robotics. The hidden opportunity: Even the headline trend of automation increasing productivity has numerous underlying themes, including machine vision, 5G, the cloud, and AI to capture, transmit, store, and analyse an exploding amount of data. These opportunities are powered by many small companies across the globe, requiring investors to have substantial regional and industry expertise. But automation is also increasingly enhancing decision-making, adding convenience and efficiency to myriad consumers and businesses. Entertainment companies use AI to improve customer content choices, insurance firms automate their customer service, and advertisers use machine learning to automate customer engagement decisions, among many other examples. In fact, it’s estimated that AI has the potential to add up to US$5.8 trillion in yearly value to 19 industries (Figure 2) .
E-commerce The long-term growth of e-commerce has brought increased convenience and accessibility to new markets, companies, and customers – something that the COVID-19 pandemic has brought into greater focus. Some may think that we are in the late stages of this disruption and the opportunity has passed. But, in our view, there are still many areas for e-commerce to grow. The hidden opportunity: Areas like grocery delivery, digital payments (Figure 2), and sustainable packaging are still very early in their growth curves. For example, grocery delivery grew by 43% in 2020 but still has less than 50% market penetration . This growth was powered by demand that was orders of magnitude higher than companies had seen prior to the pandemic, offering them the scale to invest in this area. In some countries, like China, the community group buying model is expanding the market to previously untapped populations with community leaders buying in bulk and then distributing goods to the community . In addition, the companies enabling the cloud and digital transformation continue to have significant room to grow as e-commerce reaches new sectors and segments of society.
Bottom line
In our view, the key to investing in the long-term secular themes driving tech and innovation is to look beyond the hype and the news flows. We cannot stress enough the need to dig deeper into fundamentals and understand ‘the trends beyond the trends’ that can sustain growth for the long term. We think investors need the depth and breadth of research to harness the opportunities innovation creates beyond the traditional ‘innovative’ sectors. Tech progress has marched on through the pandemic, trade wars, and economic cycles. This pervasive innovation continues to disrupt industries and drive growth while, in our view, making the world a safer, more efficient, increasingly equitable, and overall better place. We believe the question should not be ‘Have we missed it?’ but rather ‘What’s next in innovation?’ and ‘How do we capture that growth?’.
We believe traditional exposures to technology are too focused on big tech names and lack the research depth to capture the full investment opportunity in the years to come
Source: Allianz Strategic Bond Fund C (Inc) GBP; Bloomberg, as at: 31/01/2021. Strategy inception date: 21/06/2016. Past performance is not a reliable indicator of future results.
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Electric vehicles There are several high-profile electric vehicle (EV) chains that are rapidly growing. But competition is heating up from many other companies, including established automakers transitioning from combustion engines to EVs. This is a long-term secular trend that is highly likely to persist while having an important impact on the environment and society as a whole. However, with elevated valuations, many investors are wondering how to access the opportunity it presents. The hidden opportunity: While the market focuses on the automakers, we’re more interested in the massive demand they’re driving for the numerous components these cars will require (Figure 1). For example, by 2030, electronics are likely to be 45% of total car cost . Regardless of who wins the EV war, we believe the companies supplying the picks and shovels of innovation – the companies mining nickel for batteries, the advanced chip manufacturers, and the AI firms, among many others — will likely continue to have a growing market for their products, including broader use cases beyond EVs.
Inside Fidelity: Sustainable engagement
Learn about Fidelity’s active engagement
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Flora Wang, Co-Portfolio Manager
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120
million
In China, one issurance company now has over 120 millions users on its app, where over 90% of claims can be handled via self-service.
Electric vehicles will need to grow by roughly 36% per year to reach the international Energy Agancy’s 2030 sustainable development goals
36%
We’re at the beginning of a multi-decade journey of massive disruption and we see opportunities for investors to access the tech driving this innovation.
Tech innovations like digital payments, AI, the IoT, the cloud, and digital transformation are still early-stage, in our view, and are disrupting every segment of the economy, extending beyond technology and health care. We believe traditional exposures to technology are too focused on big tech names and lack the research depth to capture the full investment opportunity in the years to come. As the world rapidly changes, we think investors’ tech exposure should evolve along with it.
In our new video, we explore the technologies behind the coffee bean, highlighting innovations such as farmers harnessing cutting-edge sensors in their soil to power new data insights from AI, and consumers using advanced digital payment methods to purchase a cup of coffee. Innovation has far-reaching impacts on consumers, businesses, and society as it creates opportunities for everything from the raw materials up through the supply chain to a technology’s numerous end markets.
Digging deeper to find hidden opportunities
We believe the key to accessing these opportunities is to take a targeted, active approach to try to identify the potential winners and losers of long-term structural innovation trends across industries. We harness our deep and broad research resources to discover underlying opportunities hidden beneath the surface of well-known tech names. In our view, this helps avoid trying to pick the winners of a megatrend and instead looks to invest in the many potential winners across the supply chain. As supply chains become more integrated, particularly in Asia, companies have many different end markets. For instance, microprocessors used to sell into one industry, but they now fuel countless other sectors. Critically, we think many investors are missing the full opportunity of the firms powering these long-term themes. Below are three examples of areas where some investors worry the market is overly exuberant, but that we think continue to have robust growth opportunities beyond the headlines.
Coffee farms using drones can decrease water usage by 30% - 50%, reduce chemicals by 90%, and lower planting costs by up to 90%
90%
Yash Patodia, portfolio manager Anita Killian, CFA, portfolio manager Bruce Glazer, portfolio manager Michael Masdea, portfolio manager Brian Barbetta, portfolio manager
Source: McKinsey & Company, “Notes from the AI Frontier,” 2018. | These estimates combine the value creation potential of various AI techniques across nine business functions and 19 industries. This analysis also shows what percentage that potential value represents of the overall value creation potential from analytics broadly. For illustrative purposes only. Actual results may vary from forward looking estimates.
1 Sources: Company reports, Wellington Management. Data as of 31 December 2020. 2 International Energy Agency, 2021. 3 Source: STiR Coffee and Tea International, September 2018. 4 Sources: IHS, Deloitte Analysis. 5 Source: McKinsey & Company, “Notes from the AI Frontier,” 2018. 6 Source: eMarketer, March 2021. Penetration in online grocery is defined as consumers who have used it at least one time, meaning there is even more potential for growth within the existing market. 7 Source: Pandaily, “Why is the Community Group Buying Model Surging in China?,” December 2020.
For more insights and opportunities in the tech and innovation sector (UK, Switzerland, Germany), please visit our tech and innovation page or contact a member of Wellington’s distribution team (UK, Switzerland, Germany).
Anita Killian, CFA Portfolio Manager Anita has over 30 years’ experience investing in the technology sector, with a specific focus on the semiconductor and IT hardware industries. Yash Patodia Portfolio Manager Yash has over 10 years’ experience covering the technology sector, specialising in the software and internet sectors. Bruce Glazer Portfolio Manager Bruce has over 25 years’ investment experience in the technology and business service sectors, with specialisms in the analysis of transaction and information processing and information technology professional services. Michael Masdea Portfolio Manager Michael has over 20 years’ experience in following industries characterised by rapid change and disruption. He is also the head of Wellington’s Investment Science Group. Brian Barbetta Portfolio Manager Brian has been covering the technology sector for over 10 years and has a particular focus on internet and video game software companies, undertaking research and managing investments across both public and private equities.
About the authors
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Source: McKinsey & Company, “Notes from the AI Frontier,” 2018. | For illustrative purposes only.
Growing demand for meat and dairy due to population growth and rising incomes have exacerbated the impact of agriculture on the environment. But more sustainable food alternatives have developed significantly over the past five years. Consumer demand for vegan meat and dairy substitutes has also grown exponentially, especially in developed markets, due to the growing awareness of how dietary choices impact the world around us. Initial public offerings such as Beyond Meat and more recently Oatly have been successful, but massive levels of volatility have followed equally large waves of hype. Is the sector investable?
Yuko Takano, co-lead manager of Newton’s Future Food fund Stuart Forbes, co-founder of Rize ETF Jeneiv Shah, co-manager of the Sarasin Food & Agriculture Opportunities fund
While the rise of passive investment funds has been one of the stories of the last decade, it has not always chimed with ESG investing. To emphasise how influential passive has become, this type of investing has attracted $24.5bn (£17.8bn) in the last two years. In comparison, active equity funds have seen $5.4bn in outflows, a figure which would have been 211% higher at $16.8bn if ESG strategies were not factored in.
by Danielle Levy
Cost considerations
In addition, some passive thematic funds are not that far off their active peers in terms of fees, Sleep said. ‘For about the same price, I would much rather have a flesh-and-blood analyst assess the companies in a theme than rely on an algorithm.’ Andrew Wilson, chief investment officer at Lockhart Capital Management, shares Sleep’s concerns on costs. ‘The more esoteric you get, the more expensive passive funds and ETFs tend to be, so any relative cost benefit may get diluted,’ he said. Nevertheless, as active thematic funds can also be pricey, he believes it ‘pays to do your homework’. According to Morningstar, the average active thematic fund in Europe charges 1.39%, slightly ahead of 1.38% for a non-thematic fund. That compares with 0.5% for the average passive thematic fund and a premium over the average 0.34% fee for a regular passive fund. Passives can provide investors with broad coverage to a perceived long-term winning area, Wilson said. However, they do have one potentially significant downfall: ‘In a relatively new strategy it is not always the early adopters and winners that go on to make the best investments. ‘Therefore, a stock-specific active manager may hold out the hope of higher returns, although you would want to be convinced of their expertise.’ Lockhart Capital Management holds both active and passive strategies as part of its ‘real assets’ thematic exposure, which includes gold, gold mining companies, infrastructure, inflation-linked assets and real estate. ‘Much of this is passively invested, although we do use Gravis funds for infrastructure and Pimco for real return exposure,’ he added. Sullivan describes Tyndall as agnostic when it comes to the thematic active-versus-passive debate. The team prefers to focus on factors such as valuation, performance, beta and cost, using a mix of active and passive funds across its portfolios. For example, with gold the company favours WisdomTree Hedged Physical Gold ETC for capturing the spot price movement as efficiently as possible. ‘Complicating that trade by using active gold equity funds creates a different trade and different risk profile,’ Sullivan said. However, for exposure to renewable or clean energy, Tyndall favours the Schroder ISF Global Energy Transition fund over an iShares ETF with a similar objective. ‘The Schroder fund has achieved broadly the same outcome, but the journey taken has been far more palatable and exposes our investors to far less volatility and maximum drawdowns along the way,’ he said. ‘This is a testament to the approach of the fund management team by being sensitive to the valuations they are paying, and the balance sheet of the companies they own. Neither is a feature of the index-hugging ETF.’
One approach that is growing in popularity is utilising passives as building blocks for a wider sustainable portfolio. This is a trend spotted by Invesco multi-asset fund manager Clive Emery, who oversees five low cost risk-targeted portfolios within the fund giant’s Summit Responsible Range, comprising baskets of ETFs. To overcome the engagement hurdle, Emery works closely with the firm’s active business. ‘Passive and active will both have an important role and I think passive is evolving its approach. It is developing its proxy voting and engagement as much as possible,‘ Emery explains. ‘We can use that approach to optimise that non-financial criteria and that level of clarity and transparency in the approach that passives can bring to bear.’ Hampton believes forward looking products aligned to legislation such as the Paris agreement, which has year-on-year decarbonisation targets, are encouraging. However, she leans towards an active approach in her portfolios. ‘We prefer active approaches where the thematic exposure can be considered as part of the overall business and where valuation rigour can protect against concentration in companies where valuations are overstretched,’ she said. Some of the best performing passive strategies over 2020 were heavily tilted towards a particular theme within ESG. For example Invesco’s Solar ETF and WilderHill Clean Energy ETF delivered returns of 223% and 196% respectively. While some active funds also saw impressive returns, they remained someway off. The Guinness Sustainable Energy fund, one of the top performing clean energy funds over 2020, returned 84.1%. On top of this, the passive returns were also achieved at a much lower price for investors. The Invesco Solar ETF achieved its performance with an annual management fee of 0.5% compared to an ongoing fund charge of 1.99% for the Guinness Sustainable Energy fund, but this could come at a cost according to Hampton. ‘The difficulty for investors is knowing which passive managers have this capability and are delivering on it and which aren’t,’ she said.
Very little has been able to stand in the way of the rise and rise of thematic investing, least of all a pandemic. Over the year to the end of March 2021, global net inflows into thematic strategies, including active and passive funds, totalled $207bn (£146bn), according to Morningstar data. This figure dwarfs the collective inflows of $127bn for the preceding nine years. It was a similar story in Europe, where thematic fund assets have more than tripled over the three years to the end of March 2021 to $304bn, with the region accounting for 51% of all assets in thematic funds globally. Actively managed funds account for the lion’s share of thematic assets under management in Europe, at 88%. Although passive strategies only accounted for 12%, that is nonetheless a third higher than their 9% share of three years earlier. In the US it was a different story: here, passive funds accounted for 63% of total thematic assets under management. So, which type of strategy works best when it comes to thematic investing: active or passive? ‘The evolution of the passive industry has been significant, and factor investing and smart beta strategies have further complemented the array of options available,’ said James Sullivan, head of partnerships at Tyndall Investment Management. ‘There is a clear shift towards more cost-sensitive structures at present, and there is no reason to suggest this will not continue, supporting the launch of even more passive or semi-passive structures.’ Sullivan believes this will raise the bar for active management, while also providing passive funds with greater precision in terms of how they target and access themes. ‘Greater competition in this sense must be deemed a positive,’ he said. Peter Sleep, a senior investment manager at 7IM, describes passives as ‘perfectly adequate’ for exposure to broad themes such as global dividends or global value, where long-term research provides some assurance that investments in these areas can be profitable. However, he is not sold on using passives for narrower or more specific themes. ‘A lot of thematic ETFs are in fashionable or “hot” areas of the market. I do not think passives are good at going through the stocks associated with a theme and weeding out hype, overvaluation or picking the winners. These products pick the winners and losers regardless. ‘For this reason, I would greatly prefer active managers to do the research on narrow themes, look at valuation and timing, and pick the winners,’ he said.
Europe AUM Growth ($Bn)
The relative cost of passive funds and their lack of deep-dive research means fund selectors continue to see the value in thematic managers
Source: Morningstar Research, Date as of March 2021
by Ross Miller & Katie Gilfillan
Martin Ward, head of fund research, Psigma Investment Management
Our favoured fund is the Ninety One Global Environment fund. It is thematically driven by issues of global climate change and a decarbonising world. The managers aim to construct a high-conviction portfolio of best-in-class companies providing solutions to this global problem. Companies are linked to one of three themes: renewable energy, resource efficiency or electrification. We have been particularly impressed with the team’s in-depth approach to ‘scope 3’ emissions – the widest and toughest measure of a footprint – and how they construct their investment universe to focus on ‘carbon avoided’. This is then stringently defined as ‘the carbon emissions avoided by using a product that has lower carbon emissions than the status quo, thereby contributing to decarbonisation’. Companies must disclose their carbon output to make it into the portfolio. The team is vastly experienced, which is vital in this area of the market, and its members are fully committed to tackling climate change within their investment mindset. Generating a financial return and taking a more proactive stance to sustainable investing are not mutually exclusive. We feel this strategy will generate high levels of alpha for our clients over the long term while making a positive environmental impact through the companies it owns.
We don’t have a favourite fund but one of this year’s additions is the TT Environmental Solutions strategy. In an industry where many participants are seeking to hook on to the ESG label – validly or otherwise – it is difficult to find pure plays on climate change and the environment. The TT Environmental Solutions fund offers high-conviction, transparent exposure to climate change, the environment and the circular economy. Although it is quite young and remains small, the team is well-resourced with experience and passion. Too often we come across providers who say their ESG fund includes some best-in-class approach, referencing third-party ratings that permit the inclusion of mining companies which claim to be environmentally progressive. Or it will include a well-known retail brand that has attached a number of appropriate labels to its products, but on closer inspection remains responsible for non-environmentally friendly practices.
Peter Askew, CEO, T Bailey Asset Management
As long-standing sustainable investors, we look for thematic funds that follow and consider the United Nations’ 17 Sustainable Development Goals. An example of this is our core holding in the global thematic Ninety One Global Environment fund, which is designed to support a transition to a decarbonised economy. The positive investment strategy has been created to offset the climate risk present in many conventional portfolios. The investment team compiles annual impact reports that detail various engagements with investee companies aimed to advocate for emission-reduction measures. These reports also detail the carbon footprint of the portfolio and the direction of travel. They indicate the ongoing commitment to the sustainability aims of the fund and how the investment team hopes to achieve its long-term environmental goals.
Paul Dennis, investment director, Holden & Partners
Our internal idea generation at Quartet means thematic investing has eclipsed geographic equity allocations over the years. One of the core themes in portfolios relates to water scarcity. Water is a vital but limited resource, with growing demand placed upon its provision to sustain population growth and, by extension, economic growth. Our research highlights the need for greater efficiencies in the global provision and consumption of water, which we view as a grossly undervalued commodity. With water becoming a scarce resource, even in less arid climates, necessity really is the mother of invention (and innovation) in this context. We have owned the Robeco Sustainable Water Equities fund since 2017. The strategy is aligned with our long-term thinking and expectations for the water sector. The fund has performed well since purchase, helping to add alpha to our clients’ returns, and it provides a positive contribution to the broader theme of environmental and sustainable investing.
Oli Robson, investment director, Quartet Investment Managers
Over the past few years I have tried to become more of a conscious consumer. I buy vegetables from our local greengrocer, saving on plastic and food miles, and use bamboo toilet roll, which is made from more sustainable materials. Additionally, 50% of the company’s profits are donated to help build toilets in developing countries. Another way lots of us are becoming more environmentally conscious is through the energy we use at home – today, around 50% of the UK’s electricity is generated by wind turbines and other forms of renewable energy. In the future, I will be driving a car that is electric-powered. In Cambridge and other cities, electric vehicle charging points are already popping up. This is why one of my preferred thematic funds is the Ninety One Global Environment fund, which has a clear focus on decarbonisation and is an investment theme that will see positive growth over the long term as we transition towards clean energy and combat climate change.
Isobel Gingell, investment director, Brooks Macdonald
The value of an investment and the income from it can fall as well as rise as a result of market and currency fluctuations, you may not get back the amount originally invested. Past performance should not be seen as a guide to future performance. If you are unsure which investment is most suited for you, the advice of a qualified financial adviser should be sought. EdenTree Investment Management Limited (EdenTree) Reg. No. 2519319. Registered in England at Benefact House, 2000, Pioneer Avenue, Gloucester Business Park, Brockworth, Gloucester, GL3 4AW, United Kingdom. EdenTree is authorised and regulated by the Financial Conduct Authority and is a member of the Investment Association. Firm Reference Number 527473.
Thematic investments are making waves, not least due to their ability to turn structural shifts into compelling investment ideas. Instead of focusing on traditional criteria like countries, sectors, factors or regions, thematic investors follow a more innovative approach that enables them to make the most of upcoming trends. But there are challenges. Keeping track of the ever-increasing number of investment solutions in the thematic space is tough, particularly when there is no recognised classification. In fact, the complete absence of a nomenclature to organise the thematic universe represents one of the main issues investors are facing.
from WisdomTree
The pandemic has brought social issues into much greater prominence, clearly highlighting the social inequities and injustices that exist within the current global financial and economic system
Takes the impact of human activities on the planet into account.
Those numbers are likely to grow, especially as interest in thematic investments started to gain momentum at the turn of the century. The first wave between 2000 and 2007 concentrated mainly on growth-oriented, diversified investments and strategies with a focus on environmental and sustainability themes. While the global financial crisis brought an abrupt end to the initial rise of thematic funds, things have changed in the last five years. Interest started to pick up again, notably around technological and demographic shifts as well as environmental pressures. As of 28 February 2021, $285bn were invested in Europe-domiciled vehicles across all three areas. Gannatti pointed out that the European thematic ETF market continues to be a small player in this global phenomenon. ‘On the global scene, Europe-domiciled ETFs are growing, but they remain both small against the total due to their later entry and the earlier influence of active managers in the space,’ he said. At the end of February this year, only $36.4bn were invested in 70 ETFs in Europe. In comparison, North America recorded 218 ETFs with $154.4bn in assets, while the number of thematic ETFs in the rest of the world - mainly Asia - amounted to 122 and a total of $23.7bn in AUM. Be it active or passive, it’s fair to say that thematic funds are on a roll - and with its classification approach, WisdomTree is aiming to give investors a head start into the thematic universe. As Gannatti put it: ‘Thematic investments always tell a story. Our goal is to take that emotional connection investors have with a given story and underpin it with facts that align with how an investor envisions building their broader portfolio.’
Environmental pressures
WisdomTree’s classification provides a holistic framework for selecting thematic funds, thus taking the general lack of a standard selection toolkit into account. - Diversified thematics if funds try to harness a large number of megatrends in one go. Those strategies tend to have a broader focus, which can make it harder to find sources of potential differentiation against a benchmark. - A specific cluster if they aim to harness multiple themes within one particular cluster. For example, a fund investing in robotics, cloud and cybersecurity would be classified as a ‘technological shifts’ fund. - A particular sub-cluster if strategies intend to invest in most of the themes within a specific sub-cluster. For instance, a fund investing in cloud computing, platforms, cybersecurity and fintech would be regarded as a ‘hyperconnectivity and digitalisation’ fund. - A theme if the investment strategy is focused on a specific, clear theme. ‘We help people understand ways in which they can look under the hood. Take artificial intelligence as an example: there might be seven or eight different strategies that are focusing on AI, but they’re certainly not all the same,’ Gannatti explained. ‘Some are going to have more semiconductors, others will be more focused on software, some are going to be selected by people, others by algorithms. We believe investors should first and foremost understand the theme, so they can decide if it’s in line with their way of thinking.’ WisdomTree’s classification makes sense of the rapidly rising amount of thematic investment strategies by providing tools to track performance and flows across regions and themes, enabling investors to identify trends quicker and more accurately. On top of that, the system creates peer groups that can be used to compare funds and benchmark their performance. ‘None of the thematic funds are really trying to give you anything similar to the main benchmark,’ Gannatti said. ‘Again, I’ll use artificial intelligence as an example because there are many funds in that space: it’s nice to know whether artificial intelligence is beating the Nasdaq-100 or not, but it might be better to come up with an average performance of all AI strategies. That might tell you more about how one specific approach to artificial intelligence is doing against other approaches that are aiming at the same thing.’
A guiding light in the jungle of thematic offerings
The thematic universe is expanding
UK equities overlooked
Ketan Patel, fund manager of the EdenTree Responsible & Sustainable UK Equity Fund
Philip Harris, fund manager of the EdenTree Responsible & Sustainable UK Equity Opportunities Fund.
To fill that gap, WisdomTree has developed a thematic classification approach that divides thematic investments into 35 themes across four main clusters.
Focuses on the consequences of globalisation and the changing geopolitical world order.
Geopolitical shifts
Concentrates on themes that originate from changes in population and society.
Social and demographic shifts
Refers to everything related to technology and innovation, including the impact they have on societies and economies.
Technological shifts
We want to remind people that even though technology certainly gets tonnes of attention, there are also demographic, social and geopolitical shifts,’ said Christopher Gannatti, head of research at WisdomTree Europe. ‘It’s important to remember that you can diversify your thematic exposure in all sorts of ways that aren’t necessarily linked to technology.’
WisdomTree’s Megatrends ETF range includes:
Battery Solutions | WisdomTree Europe
AI Value Chain | WisdomTree Europe
Cloud Computing | WisdomTree Europe
Cyber Security | WisdomTree Europe
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed are as of April, 2021 and may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted, and actual results may vary. Before investing, consider the fund’s investment objectives, risks, charges, and expenses. You may obtain a prospectus or a summary prospectus on our website containing this and other information. Please read it carefully. This material is provided by Natixis Investment Managers UK Limited (the ‘Firm’) which is authorised and regulated by the UK Financial Conduct Authority (register no. 190258). Registered Office: Natixis Investment Managers UK Limited, One Carter Lane, London, EC4V 5ER. When permitted, the distribution of this material is intended to be made to persons as described below: In the United Kingdom: this material is intended to be communicated to and/or directed at investment professionals and professional investors only. In Ireland: this material is intended to be communicated to and/or directed at professional investors only. In Guernsey: this material is intended to be communicated to and/or directed at only financial services providers which hold a license from the Guernsey Financial Services Commission. In Jersey: this material is intended to be communicated to and/or directed at professional investors only. In the Isle of Man: this material is intended to be communicated to and/or directed at only financial services providers which hold a license from the Isle of Man Financial Services Authority or insurers authorised under section 8 of the Insurance Act 2008. To the extent that this material is issued by Natixis Investment Managers UK Limited, the fund, services or opinions referred to in this material are only available to the intended recipients and this material must not be relied nor acted upon by any other persons. This material is provided to the intended recipients for information purposes only. This material does not constitute an offer to the public. It is the responsibility of each investment service provider to ensure that the offering or sale of fund shares or third party investment services to its clients complies with the relevant national law. The above referenced entity is a business development unit of Natixis Investment Managers, the holding company of a diverse line-up of specialised investment management and distribution entities worldwide. The investment management and distribution subsidiaries of Natixis Investment Managers conduct any regulated activities only in and from the jurisdictions in which they are licensed or authorized. Their services and the products they manage are not available to all investors in all jurisdictions. Although Natixis Investment Managers believes the information provided in this material to be reliable, including that from third party sources, it does not guarantee the accuracy, adequacy, or completeness of such information. The provision of this material and/or reference to specific securities, sectors, or markets within this material does not constitute investment advice, or a recommendation or an offer to buy or to sell any security, or an offer of services. Investors should consider the investment objectives, risks and expenses of any investment carefully before investing. The analyses, opinions, and certain of the investment themes and processes referenced herein represent the views of the portfolio manager(s) as of the date indicated. These, as well as the portfolio holdings and characteristics shown, are subject to change. There can be no assurance that developments will transpire as may be forecasted in this material. This material may not be distributed, published, or reproduced, in whole or in part. Mirova is affiliate with Natixis Investment Managers. MIROVA Limited liability company RCS Paris no. 394 648 216 Regulated by AMF under no. GP 02-014 59 Avenue Pierre Mendès-France, 75013 Paris. Mirova US 888 Boylston Street, Boston, MA 02199; Mirova US is a U.S.- based investment advisor that is a, wholly owned affiliate of Mirova. Mirova is operated in the U.S. through Mirova US. Mirova US and Mirova entered into an agreement whereby Mirova provides Mirova US investment and research expertise, which Mirova US then combines with its own expertise when providing advice to clients
I was working for a Belgian bank, KBC, at the beginning of my career, which also had an asset management business. They hired me as a financial analyst. We were working together with an Irish team and, at the time, there were a number of common projects. Ultimately, KBC asked me to move to Dublin to further develop their thematic strategies from Dublin. Towards the end of the 90s there was a lot of talk about technology and the ‘next generation’. In contrast, there was also growing awareness of demographic changes in the developed world and KBC had launched a fund focused on investments related to an ageing population. In addition, there were also strategies related to water and alternative energy, as well as financial themes like IPOs and buybacks. Although the strategies proved very successful, a lot of the growth came through performance rather than inflows. I witnessed competitors emerge and raise millions and sometimes billions with a shorter or less compelling track record than ours. In the mid-2000s, I went with a business plan to my senior management at the time which effectively said, ‘Listen guys, if you’re serious about becoming a world leader in thematic investing, we need to build a dedicated team around that’. So we built out a thematic team which very quickly began to focus purely on the environmental side of those themes. We launched an agricultural strategy, as well as a climate change strategy and a multi-environmental strategy. Fast forward 10 years and, one day, I received a call from Philippe Zaouati (Global CEO of Mirova), who I had met on several occasions. He asked me whether I’d be interested in joining the new sustainability branch of Natixis, which a few months later was renamed Mirova. I accepted and moved to Paris.
Jens Peers CEO, CIO & Portfolio Manager Mirova US
By Jens Peers
‘We try to find companies that… are among the first movers within their peer group. Then we then try to identify the laggards. And finally we connect the dots. There's no magic formula to it, unfortunately.’ ‘Instead of being a satellite allocation, I felt that such an investment strategy could have its place in the core of an investor’s portfolio.’
For me, it was an opportunity to broaden out from pure environmental investing, especially given I had past experience managing demographic strategies as well. The way I saw it, there were so many opportunities to bring a range of themes together in a single portfolio fund. Instead of being a satellite allocation, I felt that such an investment strategy could have its place in the core of an investor’s portfolio. However, for this to work it would require the support of a large team of analysts and portfolio managers covering a wide range of areas beyond just environmental equities. This was exactly what Mirova had to offer in addition to the global reach of the Natixis organization as a whole.
As a company whose ‘raison d’etre’ is about creating a positive impact, we’ve been forced to ask ourselves whether the rise of more mainstream managers positioning themselves on the topic of ESG is a good or a bad thing. I think on the one hand it's positive because it helps raise awareness for companies like ours. Even though many of these companies may have much deeper marketing pockets than we might. But just like the water strategy I was managing back in the 2000s, at the time it probably would not have grown as much as it did if it wasn't for some big competitors spending a lot of euros bringing attention to water as an investment opportunity. That said, there’s a big risk of ‘greenwashing’, even though I very much dislike the term. It is important to make sure that people understand what the different degrees or different approaches are to ESG so that they can compare apples to apples. And that's something I feel is still missing in the market. Do we need to evolve our business model as a result? The way I see it, historically 5-10% of investors wanted to be more sustainable than the average. As the rest of the market begins to move in their direction, they may feel the need to become increasingly more extreme. For those clients we have a range of solutions, from Amazon rainforest preservation strategies, ocean clean-up strategies or land degradation strategies.
To learn more visit: www.im.natixis.com/uk/esg-sustainable-investing-solutions
It is likely that the composition of tomorrow's stock market indices will look very different than they do today. In the years to come, there’ll be less demand for fossil fuels, continued demographic change and ever more scrutiny of environmental, social and governance-related responsibilities. Companies will need to adapt their business models and practices if they are to stay competitive. And some are already making great strides in the right direction. Jens Peers, CEO & CIO of Mirova US and manager of the Mirova Global Sustainable Equity Strategy, reveals how nearly two decades of thematic and environmental investing have helped hone his skills in identifying the companies that are transitioning towards the future.
What interested you about Mirova?
We do a lot of research. We talk to people, we talk to companies. We make sure we're surrounded by good people in our own company as well. We're one of the few houses to have a dedicated ESG team that’s been together for so long. What we’re looking for is the speed at which various companies are transitioning their businesses toward the future. We see a world where the demand for fossil fuels will be in decline. It’s a world undergoing continued demographic change, be it population growth or urbanisation. And it’s a world where corporate governance and corporate social responsibility come under increased scrutiny. We try to find companies that have identified trends such as these early, and that are among the first movers within their peer group. Then we then try to identify the laggards. And finally we connect the dots. There's no magic formula to it, unfortunately.
You launched Mirova’s Global Sustainable Equity Strategy in 2013. How do you go about identifying suitable investment candidates for the strategy?
Can you provide examples of companies that have been successful at doing this in the past?
You’re the CEO of Mirova US and living in Boston. Where did it all start for you?
The coronavirus crisis has highlighted how funds focused around themes such as technology can thrive in the right (or wrong, depending on your perspective) circumstances. But tech is far from the only theme popular among investment firms. Among Citywire’s 18 thematic sectors, Ecology, Infrastructure and Healthcare strategies are those best represented (see Graph 1) in fund of fund, mixed asset and model portfolio data provided by Morningstar and gathered through our own research. The top 10 most popular thematic funds among wealth and asset managers (see Graph 2) drew a total of £8bn in net flows over the last year, and £13bn over three years. All but one – the Polar Capital Healthcare Opportunities fund – individually achieved net sales over both time frames. The Polar Capital Global Technology and Pictet Global Environmental Opportunities funds alone accounted for more than half the new money among the group over both time periods. However, they are not the strategies held in the most portfolios: that honour falls to the Polar Capital Global Insurance fund.
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We think that thematic strategies have a place in client portfolios. Thematic strategies are often managed by experts in a particular sector or area, so they are well placed to take advantage of emerging trends or sectors, which are overlooked by the wider investment community because they are hard to analyse. We hold the Polar Global Insurance fund because of the interesting attributes it brings to client portfolios. The strategy is dedicated to the insurance sector and since inception in 1998 it has delivered strong compounded returns. The team of Nick Martin and Dominic Evans, try to find the best quality insurance companies globally, focusing predominantly on those in the non-life insurance industry. The fundamentals for non-life insurance companies tend to be defensive, as insurance is often required by law. This provides a source of demand even through recessions, and means the strategy can exhibit a counter-cyclical profile and behave differently to other funds in portfolios. The team focus on high quality specialist insurers with strong underwriting credentials, and because the industry as a whole does not meet its cost of capital, the best underwriters tend to take share from weaker ones. The best underwriters also tend to be compounding machines and deliver steady book value growth.
Alastair Dean, director at Stonehage Fleming Investment Management
AB International Healthcare an active bottom up stocking picking fund with the manager and analyst team focusing on businesses rather than falling in love with the science. They aim to identify good fundamental business attributes rather than trying to predict exceptional one off binary events that occur with low probability e.g. success with one specific drug. The focus is on an attractive return on invested capital profile and the reinvestment of profits back into each business they own. This philosophy has been developed over a number of years by the manager, Vinay Thapur, who has a background in academia but has also spent considerable amount of time as an analyst and investment manager. Vinay is supported by a six strong healthcare specialised team and this strong fundamental sector specific research is a key attraction of the fund. More generally on thematic strategies, it really depends on the theme itself and if this is consistent with our house view but also the construction of each product and in particular any over exposure to any individual stocks.
The below chart shows how many vehicles hold each of the 10 most widely-held ESG funds, along with a toggle to show the minimum number of asset management and wealth management firms that own them. By scrolling over the boxes you can also see which firm or firms hold each fund in the most portfolios.
