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The growing trend towards thematic investing

Many of the world’s most serious social challenges are caused by secular forces such as population growth and demographic change, and the problems are expected to grow rapidly in coming years.

One approach to filtering investment opportunities may not be to choose a particular geography or sector but to identify stocks that are highly exposed to such secular investment themes. Investment themes transcend borders and sectors in the same way that they drive corporate strategy.

This realisation is supporting the growing trend towards thematic investing: an approach that identifies companies that are exposed to themes which offer solutions to the challenges of a rapidly-transforming world.

Thematic investing is perhaps best suited to investors with a longer-term investment horizon as well as those who are seeking exposure to an international portfolio of stocks. Thematic investing enables investors to take advantage of two opportunities:

  • identifying secular growth themes that will compound at rates in excess of the average over the long-term
  • identifying attractively-valued quality companies that use these growth themes and generate additional value on top by producing high returns above their cost of capital, and continuing to reinvest those returns for many years

We believe the following themes provide some of the best opportunities for investors over the long-term.

Education

Education is one of the most pressing socio-economic challenges today. It is a major component of well-being and a key measure of economic development and quality of life.

Education spending is already very large, accounting for around 5% of global GDP. Expenditure is expected to continue to grow by at least 7-8% per annum until 2017. Factors driving this growth include higher enrolment targets, demographic opportunities (for example the booming population of 5-17 year olds in emerging markets), more women in education, the rise of the middle class in emerging markets and increasing global mobility.

Already, education is Australia’s third largest export after iron ore and coal but it is growing at a more consistent rate.

Energy revolution

Economic, environmental and political drivers are now combining to support rapid uptake in alternative energy. Renewable energy will constitute the vast majority of new capacity added during the coming decades as the likes of solar and wind are now cost competitive on an unsubsidised basis in many locations around world. Even Shell and BP project that renewables will dominate the global energy mix by the middle to end of the century.

Despite this, renewable companies account for less than 0.1% of global market capitalisation. As it will take some time for renewable technologies to achieve the necessary scale and infrastructure to challenge fossil fuel, the short to medium-term focus will be on solutions increasing the efficiency of existing uses (cars, batteries, lighting and buildings).

Ageing demographic

We are living through a period of rapid population ageing. Globally, the number of ‘older persons’ (aged 60 and above) is soon expected to exceed the number of children (aged under 5) for the first time ever.

Despite fears that obesity and global warming would reverse the trend, life expectancy in rich countries has grown steadily by about 2.5 years a decade or 15 minutes every hour. Falling birth rates mean some countries are heading towards a potentially catastrophic decline in population.

The spending habits of this cohort increases demand for a wide range of products and services, such as healthcare (drugs, hearing aids, orthopaedics, eye care, beauty products), aged care, and specialist travel. The US longevity sector alone is currently estimated at US$7 trillion.

Obesity, health and wellness

The obesity epidemic may be the most pressing health challenge facing the world because of both its direct impacts and ripple effects on chronic diseases such as diabetes. More people across the world now die from overweight and obesity-related illness than from starvation. The annual cost of obesity-related illness in the US alone is estimated at US$190 billion or nearly 21% of the country’s annual medical spending.

Food and beverage companies are going to have to increasingly focus on the quality of their portfolios given the rising spectre of fat and sugar taxes. Mexico, which has the world’s highest obesity rate at 33%, has become the standard bearer for sugar taxes, taxing sugary drinks at 10% per litre.

More broadly, the rapidly rising demand for and cost of providing healthcare is spawning innovation in areas such as DNA to use an individual’s genetic makeup to better tailor medical treatment. Immunotherapy is likely to become the treatment backbone in the majority of cancers during the next 10 years.

Technological change

Technological development is accelerating at a rapid pace as academic research and commercial enterprise become increasingly intertwined. Themes such as mobile connectivity, cloud computing, ‘smart city’ development and big data are just a few strands in a multiplying web of developments that have wide-ranging commercial benefits.

Technology is also revolutionising traditional production processes. 3D printing has the potential to rewrite the rules of localised manufacturing. Automation is driving a substitution from labour to machines given rising wages in emerging markets and the need for productivity gains and safety improvements.

Technological connectivity is enabling more companies to locate operations overseas. There is a growing focus on long-term solutions to the ever-growing and changing array of safety and security threats against people, governments, infrastructure and society, with terrorism, cyber security attacks and critical infrastructure breakdowns recognised among the top global risks today.

Urbanisation

Urbanisation has been a defining trend in economic development for millennia but the past two decades have witnessed urbanisation at an unprecedented scale and speed. In 2008, for the first time in history, the human race became predominantly urban. By 2025, there will be 37 cities with more than 10 million people in them and only seven of them will be in the developed world.

Increased urbanisation in emerging markets raises living standards and causes a shift in the consumption habits of the population, but it requires significant investment in core infrastructure. At the same time, much of the urban infrastructure in the developed world is many decades old and in need of upgrade. In both cases, innovation is required to handle environmental and social issues, like water and waste.

 

Andy Gardner is a Fundamental Equities Portfolio Manager and Analyst at AMP Capital.

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