Thematic Investing for 2010 and Beyond
(originally posted January 25, 2010)
If the crippling financial events of 2008 and 2009 proved one thing, it’s that investors need to rethink the entire philosophy of “portfolio management.”
Today, some of the best-performing managers around the world manage their portfolios based on broad-and-potent market themes, and with good reason. It’s much easier to follow macro trends based on broad-based themes than it is to cobble together a bunch of different stocks into a portfolio and call it diversified. Theme-based investing can also be much more profitable, and it allows you to better manage your risks. In short, theme-based investing lets you have your pie and eat it, too.
When you follow themes you get the big picture. Your timing may not be perfect, but when you invest on a thematic basis, it’s much easier to determine the direction of a trend, as well as momentum and velocity of price changes. Several studies bear this out. It’s not principally the actions undertaken by a company that determine most of the movements in its share price. Research shows that price action is chiefly a function of the trend of the overall industry, as well as the overriding trend of the general market.
If you think of a theme-based portfolio as a pie, it might have eight slices:
- A slice that’s comprised of domestic companies.
- A slice that encompasses the developed markets of the world.
- One flavored by the world’s emerging and frontier markets.
- A slice formulated from key commodities.
- One containing a healthy serving of technology.
- A slice sprinkled with a thorough helping of health care and life sciences.
- One with such basic ingredients as dividend-yielding stocks and fixed-income holdings.
- And a final slice with a decidedly speculative flavoring — a high-flyer, if you will.
Theme-based investing is a powerful concept and these seven may pack the most potent profit punch for your investment portfolio. Each of these eight individual slices will contain separate fillings but share ingredients and spices. These ingredients can consist of the creme de la creme of individual companies, or of benchmarked exchange-traded funds (ETFs), indexes, as well as mutual funds that track the general theme of that particular slice of your portfolio.
1st Slice: US Companies The US investing landscape is far from being over-the-hill. You will invariably find leaders in their fields with strong balance sheets and great growth potential in the domestic basket of stocks. And you will divvy up these companies in each of the seven slices of your portfolio pie. But remember, there’s a big beautiful world out there, so don’t get hung up on allocating capital only to US stocks. You may be comfortable with domestic companies, but it’s imperative that you get acquainted with global opportunities.
2nd Slice: Developed Market Companies Your slice of developed-world international pie should have you looking at Canada, Europe, Australia, and Japan. There are global brands that are domiciled in these countries. Some of the ingredients in each of your other slices may include some of these big names. But it’s also a good idea to get some direct exposure to other developed countries through depository receipts or ETFs. There are ETFs and other investment vehicles that can give you good, liquid exposure to foreign securities.
3rd Slice: Emerging Markets That brings us to slice No. 3, the emerging markets. Face it, if you’re not invested in the world’s emerging economies, you are behind the times and missing out on what the smartest investors in the world are labeling “the future of investing.” You should, if possible, allocate capital into China, India, Brazil, Korea, the Pacific Rim, and look for opportunities in Russia, Latin America and Eastern Europe. And, don’t forget the nascent developing country wannabe’s — the frontier markets.
4th Slice: Commodities With emerging countries developing rapidly – and the rest of the world still working to wake from its post-financial-crisis slumber – the demand for commodities (the third slice) will far outstrip any supply for commodities. And that’s why you need a heaping helping of them. Whether you make an allocation to commodities because of the supply-and-demand equation, the prospect of downstream global inflation, or the short-term fact that more money managers are allocating capital to hard-commodity assets, you’ve got to follow this theme. Your ingredients need to include precious and industrial metals, agricultural commodities, mining companies, and energy plays. And don’t forget about water – the often-forgotten commodity that will be in very short supply in the years to come.
5th Slice: Technology Investing in technology, the fifth slice, should also be an easy choice. Technology is where the world is and where it’s heading. Technology changes everything – so much so that you must have an entire slice dedicated solely to tech. The ingredients in your tech slice should include the hottest themes out there – themes that are pushing breakthroughs and that are capable of creating paradigm shifts. Everyone caught a glimpse of the tech train before it derailed in 2000. That locomotive is once again chugging at a good speed and headed toward massive profitability. (see our recent article featuring technology trends in-depth)
6th Slice: Healthcare The case for the No. 6 slice – healthcare, pharmaceuticals and biotechnology – is an easy one to make. Have you ever been sick? Have you ever known anyone who’s been sick? How can you not love a market that has billions upon billions of customers just waiting for its products to come to market? The medical and pharmaceutical companies that deliver health solutions are going to explode in this decade, and that’s before you even factor in the impact of healthcare reform. You can make this slice of the pie even more palatable by spreading some capital across different segments, including some of the up-and-coming research-and-development (R&D) firms, growing and diversifying healthcare and pharmaceutical giants, generic-drug manufacturers, service providers and distribution channeling firms.
7th Slice: Income Sturdy global corporations in fast-growing business segments, commodities and emerging markets are a good start. But the confection should also put money in your pocket, even when the greater market isn’t exactly cooperating – meaning you still need income. That brings us to the seventh slice, dividend-yielding stocks and fixed-income instruments.
However, income alone isn’t enough. Ideally, this slice of pie should include investments with reasonable yields that also present the potential for capital appreciation. Top this slice of pie with good-yielding dividend stocks. In doing so, however, don’t go for the crazy yields that clearly aren’t sustainable. Look for solid brand-name companies with a history of dividend growth. Look for fixed-income (individual bonds, bond funds, and ETFs) that are stable and sturdy. But beware, as this slice of the pie needs watching. If interest rates start to rise, your fixed-income investments may take a beating. The income slice of pie should at times include hedges against rising rates. The good news here is that a flexible strategy will protect you in an environment with rising rates or escalating inflation, and will also generate huge profits if timed properly.
8th Slice: Alternative Investments For the final piece of your portfolio, have a slice that’s a la mode — alternative investments. Maybe there are takeover candidates that you’re willing to dabble a little in. Maybe use this slice to invest in some private-equity plays, real estate, agriculture, art, or precious metals. Individuals and institutions continue to allocate an increasing portion of their portfolios to alternative investments. These investments are uncorrelated with traditional stock and bond markets and are designed to greatly reduce risk, increase returns, or both.There are thousands of options when seeking to diversify into alternative investments. Most are incredibly expensive, tax inefficient, highly illiquid, or simply not worth the risk given their expected return. This leaves a small minority of possibilities to choose from. We believe it is possible that an allocation to alternatives can improve your odds of having a successful investment experience. Only after a significant amount of analysis can we determine how much exposure is reasonable and what strategies are prudent given your individual circumstances.
You can purchase top notch ingredients and use the techniques provided to make your own pie or you can have an artisan bakery do it for you, versus a large factory baking an unsavory pie of few flavors. If you don’t have time to compile all the ingredients and watch your pie while it’s in the oven, then:
- Make sure your investment manager understands what it is you want.
- Make sure he or she adheres to your philosophy of pie-making.
- Make sure that they explain the ingredients they are adding in and how it’s going to make the whole pie taste.
- And last but not least, make sure you get to eat your pie.
Occasionally, you will have to take profits and diversify with more ingredients or pie slices, but don’t add so many ingredients for the sake of calling your portfolio diversified. Many great-performing managers – and by great I mean managers that vastly outperform the averages – have more concentrated portfolios. If you insist on buying a fund related to the Standard & Poor’s 500 Index, buy an index ETF with corresponding low fees and efficient tax management.
But if you want a truly diversified portfolio – with powerful opportunities – stick to big themes and use the very best ingredients and be selective of your spices! At Green Valley Wealth Advisors our artisanal work is our investment management discipline; advise with conviction that is genuine.