Business Development

084 | Megatrends and Thematic Investing

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Tutors:

  • Rob Powell, iShares Investment Strategy & Insights
  • Camila Beeston, iShares UK Wealth Sales

Learning outcomes:

  1. The difference between megatrends and thematic investing
  2. The long-term nature of investing in megatrends
  3. Integrating thematic investing into an overall client portfolio

Channel

Business Development
PRESENTER: Rob, what exactly is a megatrend? ROB POWELL: So, a megatrend is a long-term transformative force that is going to effectively change the global socioeconomic and political landscape over the long term. So we’re thinking about things that are going to be altering the way we live, the way we work, the way things operate over 10, 20, 30, 50 years potentially. Rather than just looking at investment outcomes over one and three years, megatrends are about taking that longer term view. PRESENTER: And Camilla, you’re out there talking to investors the whole time. Are investors happy to take a 20, 30, 40-year investment timeframe? CAMILA BEESTON: I think they are at the moment, because this is a great story that they can then discuss with their end investor. If you think about we’ve been in a decade long low return environment, clients are really reassessing the way that they think about traditional asset allocation. And they are really moving towards considering thematic investment strategies as a new way of constructing their portfolios. PRESENTER: We’ve talked about megatrends and thematic investing, are they the same thing Rob? ROB POWELL: So that is actually a key distinction that you highlight. So megatrends are these long-term transformative forces that are going to, as we already talked about they’re going to affect the long-term environment. And thematic investing is a way of accessing a megatrend. It’s not to say that you would necessarily launch an investment product based purely on a megatrend. So if we think of megatrends as things like changes in demographics. So a change in demographics could be anything from the rise of the Chinese consumer, the growth of the millennials as a portion of people let’s say, and ageing, the ageing population and the effect of the ageing population on the world. So if you launched an investment product based just on demographics you would get something that was incredibly broad. So thematic investing is all about going two levels down from a megatrend. So let’s say the second or third order effects of a megatrend. And highlighting something like the ageing population, and designing a product through which you can benefit by accessing the aging population trend. PRESENTER: And Camilla, we’ve had thematic investing before. I can think of technology funds, financial funds and so forth. What’s the experience been, how are investors feeling about those? CAMILA BEESTON: I think yes, as you pointed out thematic investing, it’s nothing new. But I think what is new now is with the ability of technology and the incredible amount of data that’s out there to be collected. Finally we’re at a stage where we can systemically process all that information and convert it into a passive vehicle, be it an ETF, and I think that’s the new force that’s available to clients now to tap into. PRESENTER: Well I wanted to come to whether it’s best to go active or passive on those in a moment, but before I do what’s the difference between a megatrend or thematic investing and something that’s got long-term legs, or something that’s just marketing hype? CAMILA BEESTON: Well I think this is the key challenge for clients. Because you need to be careful that when you’re thinking about a megatrend or thematic investing it is truly a long-term structural driver that’s changing as Rob mentioned the socioeconomic landscape. Yes there is market hype, and I think what’s fantastic about the data that I mentioned before is the ability to systematically assess that. You really can pick out, I don’t want to say winners from losers but hopefully you are monopolising on the future winners of tomorrow, rather than short-term, say, abstract trend. PRESENTER: But Rob, we mentioned there that megatrends are first, these very broad first order effects. What are some of the other major ones that are out there? You mentioned demographics. ROB POWELL: So if we think of another megatrend, let’s think of something like technological breakthrough. So many participants in the market at the moment are saying that we’re actually undergoing the fourth industrial revolution. So what does that mean? Well that means that the way we work, the way we live is being altered by technology in a way that it hasn’t been for quite some time. So we’re actually seeing a quite significant shift in the dynamics of how people are working. So if we think about something like robotics and the potential for the usage of robotics in the workplace. If we look at all of the primary school children that started school in September last year, it’s estimated that around 65% of them are going to have jobs by the time they’re 21 that don’t currently exist, and that’s because of the rise of themes like robotics. As the cost to produce a robot goes down, which is a trend that we’ve seen over the recent past, and their efficacy or their efficiency to actually add value within the workforce, particularly in areas such as manufacturing increases, we are going to see an increase in the number of robots actually infiltrating the workforce, and traditional working practices are going to have to change as a result of that. PRESENTER: So technology and demographics are two megatrends, any other crucial ones? ROB POWELL: So if we think about the reduction in fossil fuels that could be seen as a megatrend as well: the need for the world to actually find new sources of energy. So the boom in things like solar energy and wind energy and tide energy, that’s an example of a megatrend that is going to be taking hold over the long term. As fossil fuel supply continually reduces we’re going to have to come up with new technologies to actually change that going forwards. PRESENTER: And Camilla, a little earlier you mentioned indexation. Why is that, or why do you think that’s so important as part of this way of getting exposure to megatrends? CAMILA BEESTON: Traditionally thematic investing has been accessed through active managers. You know, that’s been around for 10, 20, 30 years. But I think the real value add that indexing can provide is you’re systematically assessing thousands and thousands of stocks. You’re looking at the revenues that these companies are producing, and it really allows you to get very granular, and directly attribute businesses, companies that are directly benefiting from megatrends. So you’re keeping a very broad but also diversified exposure to thematics and megatrends. PRESENTER: How is that different from what an active manager would do? CAMILA BEESTON: Well you could argue that when you’re selecting on a single stock basis perhaps it’s more difficult to identify the future winners of tomorrow. Obviously there are active managers out there who are hugely successful at thematic investment. But as I mentioned earlier with the availability of data now passive just brings another way to access thematics at a very low cost. PRESENTER: And as you look across your client base is thematic investing something that institutional investors have got a lead in, or is it something that retail investors, wholesale? CAMILA BEESTON: So far I must say it’s resonated mostly with the IFA and the private banking market. So, with the story that Rob told earlier about automation and robotics, those are the kind of stories that end retail investors are really locking onto. Clients, they read the news, investors are much more aware of what’s driving the social political landscape around them, and I think they want their portfolios to work harder for them, and they also want their portfolios to engage with the things that really are affecting their day-to-day lives. So we’ve had much success in that area. PRESENTER: Now the behavioural finance camp would say storytelling can be really dangerous, it’s superficially attractive but it’s not always the best thing to do with your money. What would you response be? CAMILA BEESTON: I think as long as the story is a way to illustrate to the end investor, and it’s based on sufficient evidence, which is what a lot of this data mining exercises do, they really look at these trends and go down the balance sheets of these companies, then I think it’s just a good way to illustrate how this megatrend can come to life for an investor in that portfolio. PRESENTER: And we’re talking about very long timescales here Rob, I mean wouldn’t a cynic say well it’s great for a fund management group to say this, they take the money off us and if we get two, three, five years of bad performance the answer’s you haven’t invested it with us for long enough. ROB POWELL: I suppose that argument works both ways really. I mean as I said before this is an invitation for investors to actually look beyond that one and three-year view that has historically dominated investment objectives really. So traditionally active managers have been paid on their one and three-year performance, and this is all about actually looking beyond that and actually saying there are certain factors that are going to be driving the long-term performance, but also having a massive impact on asset allocation in the short term. And these trends, these thematic exposures are ways of actually accessing those long-term themes. PRESENTER: So over what time period should somebody judge whether a thematic fund from a provider such as yourselves make sense or not? ROB POWELL: I think it’s down to the individual investor and their own objective clearly within the portfolio context. So it’s down to the client and having a view on their, how long term their money is going to be invested for, and the risk levels that they’re prepared to take. Clearly these kind of exposures are going to be exposing the client to slightly different risks to a standard one beta exposure such as an S&P 500 product, which just invests across the whole market. This is going to be slightly more concentrated, potentially, and therefore have a different risk profile. So I think more akin to a growth style product where you’re going to have potential for outperformance over the long term, but also at slightly elevated levels of risk over rolling periods. So I’d say that weighing those two factors together of actually the client’s objective and the knowledge of the product that you should be looking to hold these for over five years at least to actually gain from the development of the theme. PRESENTER: Camilla, all of these big themes, are any of them income themes or are these all about capital growth? CAMILA BEESTON: These are all about capital growth. As I mentioned earlier it’s about spotting or trying to profit and identify the potential winners of tomorrow. So as Rob said five years plus is the horizon that we’re looking at. PRESENTER: Rob, you mentioned robotics and automation earlier, but why will they necessarily make money? I mean couldn’t you put together a very credible scenario that basically puts everybody out of a job so we all end up on a universal minimum income. It’s robots that make all the money, and it’s a sort of dystopia with deflation put in. ROB POWELL: So it goes back to the point that I made earlier on I suppose that actually the world is going to have to develop. And 65% of those school children are going to have jobs that don’t currently exist by the time they’re 21 as I already said, and that’s because we’re going to have to develop new skills. And maybe the skills base that people currently have isn’t suitable for the working environment that there’s going to be in the future. So The Economist for example recently ran a piece on its front page about the changing face of education, which directly addressed the robotics trend. So clearly there are some risks in the development of these kind of themes, and the negative person would say that this is going to end in catastrophe. The more positive among us might say we’re going to develop new ways of thinking which are actually going to improve productivity, and actually improve things for human beings in the future. PRESENTER: And Camilla, is there any estimates or guesstimates as to if you go for one of these long-term growth themes how much more growth it’s likely to be than if you just stick with traditional equity investing? CAMILA BEESTON: Well, that’s an interesting question, because a lot of our client conversations have been based around that. And people are really trying to find ways in which they can actually now implement thematics in their portfolios. And I would say the real trend so far has been replacing a core part of your global equity allocation. So let’s say the MSCI ACWI IMI index, subbing out say 5-10% of that, and putting in the thematic funds. What does that do to the portfolio, what does that do to performance? And there are three main scenarios that we can think of here. You can mimic the country weightings of the ACWI IMI index through a number of the thematic funds. So let’s just say you take two; aging population and healthcare. You can mimic that country weighting. PRESENTER: Sorry just to be clear, these are two products, you’re using them as examples, these are two products you have. CAMILA BEESTON: These are two products yeah. Or you can be slightly more sophisticated and include all four, but through that variety of combinations over a five year period it does actually outperform MSCI ACWI IMI anything between 3½-4½%. PRESENTER: And this is historic data is it? CAMILA BEESTON: This is historic data, and these funds were launched in September, so there is not a huge amount of real live performance data at hand yet. But based on a five year back test those are the kind of results that we’re seeing. PRESENTER: And what are the implications if you start to put say a 10% sleeve in? What are the implications? Presumably a lot of these stocks you might hold in your conventional equity portfolios anyway. Aren’t you just doubling some bets up? CAMILA BEESTON: Again something that we are regularly asked. There is a little bit of crossover between some of our funds, so as you would imagine the ageing population fund and our healthcare fund there is stock crossover of about 30/32 stocks crossover, but with the rest of the funds they are actually pretty demarcated from one another and they can be used standalone and together. PRESENTER: Well you mentioned there’s a 32 stock overlap, just give us some idea of how many stocks you have in one of these thematic funds you’re talking about? CAMILA BEESTON: So of the four that we’ve launched there are some constraints. So the fund must contain at least 80 stocks. And that’s to avoid concentration. So with the four funds there’s anything between 80 right up to about 260 in our ageing population fund, so that’s the most broad and diversified fund of them. PRESENTER: And Rob, if you’re looking at I guess companies and investment ideas over 20, 30, 40 years, does this mean you’ve got a very big bias towards small caps in any of these long-term growth themes? ROB POWELL: That’s a great question. Obviously we’re looking for smaller companies that are going to become bigger within our portfolios. And that’s the reason why these exposures are designed to actually have large mid and smaller company names within them. I wouldn’t say that it ends there. One of the key construction characteristics of the funds is that they’re actually equally weighted. And what this does is this inherently takes you away from the larger names within the universe from which you’re selecting, and puts more of an emphasis on the smaller names. And that’s all about giving those smaller names more of a chance to actually affect the holistic risk return profile of the portfolio. PRESENTER: But how can you show that any outperformance is down to the theme, and surely someone would say it’s just the small cap effect? ROB POWELL: That is obviously a consideration. There is going to be a theme of mergers and acquisitions within a portfolio, within an exposure such as this. So with that emphasis on smaller names, and with names that are coming up with new technologies and providing the potential for structural growth, it’s likely that you are actually going to have larger companies trying to gain access to those kind of themes. So you do have some of the key drivers of the returns are in the smaller end of the space. But that’s not to say that actually the larger companies can’t have an effect on the risk return profile in an equally weighted context. There are some large companies, think about Apple for example, that is growing incredibly quickly. So it’s just about giving the large and the small companies within the universe the chance to actually affect the risk return profile. PRESENTER: And do you have any opportunities to buy private companies, things that aren’t listed on markets? ROB POWELL: No, so sadly not. Obviously with these kind of themes, these new technologies that we’re honing in on, a lot of them are actually in startup format. Clearly in a passive vehicle, which is what we’re focused on today, it’s very difficult to actually implement or to gain exposure to private companies, and to startup companies in a way that you would in another type of investment wrapper. So these have to be listed on major stock exchanges to actually make their way into the portfolio. PRESENTER: And Camilla, is there a bit of a challenge to traditional asset allocation if you start to buy into this megatrend way of looking at the world? CAMILA BEESTON: I think that it is a challenge, I suppose, but it’s more, the way we view it is more an overlay to traditional asset allocation. I’m by no means saying traditional asset allocation is dead, I don’t think we’re there yet. I think thematic investing is just another element to add to your portfolio, and way for your end clients to engage with what’s going on around them as well as in investment. PRESENTER: And what’s the sort of feedback you’ve had from clients when you’ve been talking about it, how has it changed the way that they communicate with their clients? CAMILA BEESTON: It’s resonated very well with clients and their end investors. Partly because of the story element that I did refer to earlier, but also I just think that clients really are reading the news, they see what’s happening in the markets, they see what’s happening with the changing landscape. As Rob mentioned automation and robotics has been the most popular fund so far. And people just like to try something new I think, be more creative in the way that they’re deploying their money. PRESENTER: But Rob, do all of these funds essentially give you a very big US bias, given that the States is such a cradle of innovation? ROB POWELL: That’s a great question as well. Clearly broad equity indices are dominated by the United States. So if we think about something like an MSCI ACWI exposure it’s going to be 50% to 60% United States anyway, so a dominance there for normal equity exposures. Interestingly actually there isn’t a clear dominance towards the US; in fact in relative terms it’s actually underweighted in lots of cases compared to broad market exposures. Maybe that’s because some of the more emerging areas within the portfolio are the ones which are driving the technology. I think a really interesting example is when we think about the ageing population trend that we’ve already spoken about, one of the things that surprised me most when I started looking into the them was how much, how weighted towards to the emerging markets it actually was. So we’re seeing the trend take hold faster in China pretty much than anywhere else. So we expect that by 2050 that there’s going to be 120 million people over the age of 80 in China alone. So you can really see the development of the trend in a place where you wouldn’t necessarily expect it to be taking hold. PRESENTER: But is that a function of the fact that China’s just got a very large population? I mean is 120 million going to be a big issue for them out of their total population? ROB POWELL: I mean it is a function of the fact that they’ve got a very large population, but it’s a large increase from where we are now. And if we think about the number of countries in the world that currently have over 30% of their population, just thinking of a different way of looking at it, if you think of the number of countries in the world that currently have over 30% of their population over the age of 60, there’s currently only one country in the world that’s in that situation, and that is Japan. By 2050, we’re going to be looking at more like 55 countries according to the UN that have that dominance of the over-60s within their population dynamic. So you can see a real broadening out from developed markets more towards the emerging markets, which is why it’s good to have exposure to the emerging markets in these kind of products. PRESENTER: And just going back briefly if I may to this whole issue of the active or passive, how constrictive do you want your rules to be around passive here, because if you’re looking at a trend on a 50 year view presumably you need to build a bit of flex in? CAMILA BEESTON: Yes, and I think people’s first guess would be passive means relatively static, and I think that’s a misconception. So let’s take the breakthrough healthcare index for example, a passive ETF. Over the last five years the country weightings of that index has actually changed quite considerably. So you mentioned the US earlier. The exposure to the US has actually come down by 15% in the last five years, and new countries have entered the index like Finland, Israel, as more companies within those countries enter the breakthrough healthcare market. So even though it’s passive it does allow you to dynamically capture the evolving theme. Obviously that’s something that an active manager can do on perhaps a more frequent basis, but these funds, they are rebalanced on an annual basis, so they are realigning to the theme. ROB POWELL: I would actually say that it’s not necessarily a case of active or passive when it comes to actually looking at these kind of exposures. I would say that actually it makes most sense to compare the two side by side, rather than having a passive bucket and an active bucket when it comes to thematic investing. As Camilla already talked about, with the way data availability has developed over the last few years we can now actually get access to very specific yet broad exposures through a passive product in a way that we couldn’t do in the past. Which means that we can actually focus on thematic trends in ways that previously were only, only active managers were able to do. Does that mean that you shouldn’t compare the two together? I don’t think so. I think the outcome that they’re aiming to provide is very similar, so the two should actually be, the pros and cons of both should actually be analysed side by side rather than being very separate. PRESENTER: Well if we’re talking about index fund investing, I mean ultimately whose index is it if you take something like breakthrough healthcare? Is it something that iShares has created, what is it? CAMILA BEESTON: So iShares actually worked with Fact Set to produce the indexes which we run the thematic funds off. And Rob, perhaps you want to delve more into the methodology of how we went about that. ROB POWELL: Yes, so we worked before the launch of these products, and before the launch of any products we’ll do a lot of work with potential index providers on the construction of the portfolio and the actual methodology of how we’re gaining access to the theme which we’re trying to access basically. So as Camilla said we work with FactSet who are a data provider, who provide a lot of, who provide all the insights with regard to classifying the underlying companies, to ensure that we’re actually gaining access to the themes that we want to focus on, but also stocks who are the index provider. So it’s been working with those two other parties to actually provide a product that actually is implementable in a passive wrapper for our clients. PRESENTER: Would you see it as a pure beta play or closer to being something that’s I suppose smart beta? ROB POWELL: So it certainly muddies the line between traditional beta and I would even say active management. So maybe to a certain extent it’s actually encroaching on what an active manager is aiming to do. So unlike a traditional passive product which aims to track a benchmark index, this is actually, this does aim to track a benchmark index as in the index provided by stocks. However that index is actually designed to generate some level of outperformance against the broad market to actually improve the risk return profile of people’s portfolios. PRESENTER: And given this is, these are all products which I guess you would want to claim as the more sophisticated end of the market, how do you price them? Are they priced like a conventional index fund like you were buying the FTSE 100, or do they carry a higher fee level? CAMILA BEESTON: So currently we have four funds, and they’re all price at 40 basis points. So we have ageing population, breakthrough healthcare, digitalisation and automation and robotics. But what’s great about this is it’s a scalable platform. So we do have the four funds that I’ve just mentioned, but with the data capability and the methodology that we’ve now designed, this gives us the ability to launch further funds as megatrends emerge further down the line. So watch this space. PRESENTER: But Rob, how do you narrow the stock universe down? Can you talk us through that, because if you say something like a megatrend, like aging populations, it’s so broad it’s a bit like trying to grasp smoke? How do you then work out what the sub-themes are underneath and pull something together that you think works, rather than just a collection of stocks with a nice marketing spin around the outside? ROB POWELL: I think if we think of thematic investing in the same guise as traditional sector investing for example. You think about sectors within financial markets, it’s a classification provided by a data provider effectively. So if we think of GICS classifications, the well-known way of dividing up broad markets, you have 10 GICS sectors, anything from healthcare to telecommunications, to basic materials. And it’s their classification of companies. And each company has to sit within one of those 10 sectors. And that gives you a view, enables you to divide up the market. The way that these products are actually, or these indices are designed is actually very similar in terms of actually how they divide up the market, but they go into a lot more detail. So rather than stopping at the 10 sectors, we actually got six levels of granularity further down. So we classify companies if you like six times, in six times more detail. And that means that you end up actually having 1,600 sectors into which companies can be classified. And the really clever thing about a thematic index is actually defining the list of those, list of sectors from the 1,600, which are actually relevant to the theme. So the key is actually defining which of those 1,600 sectors are actually relevant to the ageing population trend for example. And once you’ve done that you can actually say all of the companies within a set of constraints that sit within that predefined list of subsectors if you like, can actually make it into the portfolio. PRESENTER: And Rob, these are obviously very long-term growth products, when you’ve done the backtesting are there particular market conditions they do well in or ones where they tend to struggle a bit against the main index? ROB POWELL: I would say it’s more down to idiosyncratic risks within the portfolio rather than external factors that are going to be affecting the portfolio too much. Obviously that is, they are going to be, they are unavoidable, they’re undiversifiable risks in lots of cases. But if we think about the performer, the best performer over the last few months, it’s been the robotics fund out of the four. Why is that? It’s because of the strong performance of a number of names within the portfolio. So as I said it’s the idiosyncratic drivers of the risks within the portfolio that are actually going to be driving the risk and return profiles. So that’s why it’s actually a very interesting proposition to be able to have this kind of exposure in a passive wrapper, because what is different between a passive fund and an active fund is that you can see on a day-to-day basis as an investor in the fund all of the underlying constituents. And this gives you the ability to actually think about what’s going to be driving the risk return of the portfolio on a day to day basis, rather than having a bit of a lag and seeing what’s happened in the past. CAMILA BEESTON: I think that’s also what investors have found has resonated with them, because as Rob said it’s a completely transparent fund. You can actually look down to the single line holdings of each theme, and see what’s in there, what matches the granular sectors that FactSet have put together. So if we take ageing population as an example, there’s such a varied variety of companies. So you’ve got a Japanese golfing company because people play golf when they retire. You’ve got Carnival Corporation, the cruise ship liner, because obviously people like to go on cruises when they retire as well. So it’s much more interesting I think than you would necessarily think at first instance when thinking about a passive vehicle to access a megatrend. PRESENTER: And given that what’s the point of blending megatrends? If there’s quite a lot going on under the surface are there stats out there to say that if you blend aging demographics with, I don’t know, robotics, it gives you a very different risk reward characteristic in your portfolio than healthcare with something else? CAMILA BEESTON: I mean as you mentioned earlier there is some crossover, so say aging population and healthcare. They kind of lend themselves to one another. But in terms of blending all four there isn’t any other stock crossover, so no you could use them however you wish. ROB POWELL: I suppose as well it’s a factor of the investor deciding which of the trends that they actually buy into. We wouldn’t necessarily say that all investors are going to necessarily be positive on all of the four products that we’ve launched. And there’ll be some who have had more exposure let’s say to one of the trends or other, which is going to actually make them more positive on it. PRESENTER: But I suppose if I say bought a financials fund I kind of intuitively know the types of market conditions or the interest rate environments that will tend to favour that, and the conditions when it won’t necessarily do as well. Is there something similar that you can say of any of these themes, or are they in a sense you’ve got so much diversification underneath, within that themed fund it’s impossible to second guess? ROB POWELL: Yes, I mean these are all very broad exposures. So you do have that diversification which is similar to investing in a standard passive product. It’s a more growth focused potentially cyclical exposure than a defensive exposure. So in a period of strong economic growth where companies are actually investing a lot in R&D there is potential that these can actually generate some level of outperformance. CAMILA BEESTON: Also it’s sort of changing your mindset to the way you think about investment in the sense that with more traditional investment market capitalisation, the winners of yesterday, hopefully they’ll carry on winning out tomorrow; whereas this is a really forward thinking, almost investing in the potential of the trend moving forward than historical data in the past if that makes sense. PRESENTER: Well we’ve got through a lot of in the last 30 minutes. Unfortunately we do have to bring it to a conclusion now. So if there was one key reason you could give as to why people should think about mega trend investing today, what would it be? ROB POWELL: I think if you’re interested in gaining some level of structural growth within a portfolio in this low growth environment in which we’re living, and you’re also willing to actually look beyond that one and three-year view that’s dominated investment portfolios in the past, that these can actually provide some very interesting opportunities. CAMILA BEESTON: Yes, I would agree with Rob. And I think the ETFs that we’ve launched at iShares, they’re a cost effective transparent way to actually access these funds. So if anybody is interested I would recommend that they go to our website, they can really have a look what stocks are in there and get involved in thematic investing. PRESENTER: Camilla Beeston, Rob Powell, thank you both very much. ROB POWELL: Thank you. CAMILA BEESTON: Thank you.