Global tailwinds provide lift to investments

Having seen rising stockmarkets in the past five years, high net worth investors, who are today generally underexposed to equities and still sitting on cash and bonds, may worry they have missed the boat. But they need not.

While attractive equity opportunities exist in several markets and sectors, thematic investing is most appealing because of its forward-looking approach which seeks to identify structurally growing companies, typically across a variety of sectors, operating in industries with long-term ‘following winds’.

If GDP growth or other macro-economic variables behave quite unpredictably, identifying global mega trends expected to have a major impact on human kind and believed to support business growth over the longer term can provide a more stable investment framework.

As such, thematic investing is considered as a valid alternative or a complement to a geographic or sector approach, and most suitable to today’s integrated global economy.

A key thematic driver informing investments and stock selection today is demographics. With the global population expected to increase from roughly 7 to 9.6 billion in 2050, according to UN estimates, investment opportunities and challenges are expected to emerge.

“There are going to be more people in the world, which means there is going to be more demand for basic consumer goods like toothpaste, shampoo and so on,” says Sam Jeffries, partner and head of private client investments at Sarasin & Partners.

Global companies such as Colgate or Palmolive may seem rather dull and uninteresting, he says, but in fact they will enjoy structural growth simply because there are more people needing to clean their teeth or wash their hair.

An example of a more appealing company set to benefit from this trend is International Flavors and Fragrances, a US-based company which Sarasin owns across its client portfolios. As population grows, there is natural organic demand for flavouring, as manufacturers such as Procter & Gamble see new fragrances as a key way to innovate their products, and the American firm stands to benefit from the organic growth of these corporates, explains Mr Jeffries.

The other side of the coin is that not only is population increasing, but people are also living longer, given significant improvements in healthcare and medical science over the last 20 or 30 years. The number of people aged 60 or more is projected to more than double by mid-century, from 841 million in 2013 to more than 2 billion in 2050, according to the UN.

The ‘baby boomer’ generation born after the second world war has grown to become the healthiest and wealthiest ever to retire, according to Lombard Odier, which runs the “Golden Age” fund based on this theme.

“The over 60s represent an expanding, cash-rich group of consumers who are happy to spend,” states Meret Gaugler, equities analyst at Lombard Odier Investment Managers. “They are less sensitive to the economic environment than the wider population and for these reasons, businesses serving senior should grow faster than the rest of the economy.”

Investors who want exposure to the trend of an ageing demographic should think wider than the healthcare sector, as people are increasingly healthier for longer, they are active and spend money. Next to drug companies, care home operators and manufacturers of dentistry equipment, companies that will benefit are holiday resort chains, casinos, cosmetics companies or dedicated retirement planners, according to Lombard Odier. 

When investing in a theme, it is important to drill down into niche areas and seek established businesses with remarkable cash profit, able to build good barriers to entry in their businesses, explains Simon Edelsten, manager of the Artemis Global Select fund.

In the ageing population theme, regarded as one of the most reliable following winds and one of the best performing in his fund, Mr Edelsten identifies two different and uncorrelated sub-themes: the first one is implemented through consumer, cyclical stocks related to the spending trend, and particularly the ‘grey dollar’ spending theme, given that the vast bulk of the ageing baby boomers live in the US. The second invests in defensive healthcare stocks.

With research data highlighting that ageing baby boomers are very keen on exercise, particularly of the outdoor variety, the fund invests in companies in cycling and hiking and owns stocks such as VF Corporation, owner of The North Face clothing range and Japan’s Shimano, leader in producing bicycle brakes and gears.

A characteristic of both companies is their ability to innovate products through advanced technology and the fact they operate in industries with high barriers to entry.

As the growing demand for healthcare faces the limited budget of people and governments, Artemis’ approach is to look for companies producing affordable, cheap healthcare, such as generic drug manufacturers or wholesalers who for example ship cheaply made but high quality Indian drugs into Western pharmacy chains. One of the fund’s biggest holdings is Actavis – the world’s second-largest generic drugmaker which recently acquired Forest Labs for €25bn – whose business is focused on supplying pills at cheap prices but which are the chemical equivalent of the more expensive variants.

If an ageing population, and the growing occurrence of diseases, is the thematic driver for investing in healthcare, the sector is particularly appealing for its growing dividend yields, in the context of European or global recovery, says Rajesh Tanna, CFA, portfolio manager Emea at JP Morgan Private Bank. “The dividend yield in Europe is still attractive and, within Europe and globally, healthcare is key for our growth in income,” says Mr Tanna.

Businesses in healthcare show underlying profit growth and, having scaled back significantly on their R&D over the last five to eight years, are now expected to pass back returns to shareholders, he says. “We are buying healthcare stocks on the basis of cash flow generation, underlying growth and quite nice returns to shareholders. This is definitely one of our core themes within the private bank.”

Another key investment theme revolves around the increasing wealth of the emerging market middle class. The size of the global middle class will increase from 1.8 billion in 2009 to 3.2 billion by 2020 and 4.9 billion by 2030, according to the OECD. Asia is expected to represent 66 per cent of the global middle-class population by 2030 compared to 28 per cent in 2009.

As people get wealthier, their spending habits change, with more money being spent on consumer discretionary items. Large private banks such as JP Morgan and Credit Suisse are strong supporters of investing in firms exposed to the structural growth opportunity of the emerging market consumption story.

In particular, most of the European consumer staples and some of the discretionary businesses with exposure to developing economies have produced very solid results recently and look attractive, reports JP Morgan’s Mr Tanna. Consumer staples businesses have significantly derated in the last year, as the negativity towards them fuelled by concerns about growth of emerging markets is still very strong, he says. These stocks are appealing particularly in the short term, as the environment does not look as bad as the market perceives, as well as the longer term. Luxury brands with a more mass brand appeal are also interesting, as are some of the auto companies having exposure to the theme.

Results from the latest Emerging Market Consumer Survey carried out by Credit Suisse and AT Nielsen highlight for the first year a drop off in consumer optimism, but several interesting sub-trends have emerged: young people appear to have a higher income than their elders in many emerging markets and, as a consequence, there is strong demand for sportswear goods in countries such as Indonesia, India, China and Saudi Arabia. Also, rural income expectations are rising steadily in India.

These research results provide some guidelines in terms of different spending trends and the companies that can benefit from them. “We have yet to see a strong buy signal for broad EM. We need to be selective, but the consumer story does have a very structural thread,” says Mike O’Sullivan, CIO UK and Emea at Credit Suisse.

One of Sarasin’s top picks to play the emerging market consumer story is a South African company called Mr Price, which manufactures fashion apparel at competitive prices and with good quality and has first-mover advantage. Already a well known brand in South Africa, the firm is also expanding into new markets, such as Ghana and soon Nigeria, benefiting from the growth of the African middle class consumer, which has tripled in size over the past 30 years and is expected to double again in the next 20 years, reports Sarasin.

Tech revolution

A long-term investment theme with disruptive power and growth potential is the technology revolution, which is drastically changing consumers’ behaviour. For example, the life-changing effects of technology on communications are clear. Social media companies have become global forces and the recent takeover of WhatsApp by Facebook for $19bn (€13.6bn), one of the biggest ever tech acquisitions, demonstrates the importance for these large corporations of staying ahead of the competition.

Sarasin focuses on the concept of technology leapfrogging, which has allowed for example telecoms companies to advance at much faster rate in developing countries.

Attractive stocks are also found in the satellite and cable providers space, where increasingly companies realise the importance of having the security of their supply chain, with TV companies owning the content. An example of stock held by Sarasin in this space is satellite operator SES, which owns 25 per cent of all satellites in orbit.

Technology is just the infrastructure for a broader investment theme, which French asset management Natixis labels “digital economy”.

The emergence of a digital economy is dependent on the development of operational infrastructure, such as telecom and cable networks, satellite fleets, data centers and IT solutions, and the contribution and innovation of technological companies, explains Yves Maillot, head of Natixis Asset Management’s European equities investment division.

The firm has identified three stages in which the digital economy is spreading across the corporate world. In the first stage, companies mainly in the bricks and mortar universe use digital technologies either to access new customers or to provide new services, but their core business model remains unchanged. In the second stage, companies need to reinvent or rethink their strategies and review their business models, as they are facing competition from others that are early digital adopters, with several cases today found within the media and advertising corporate world. In the third stage companies are 100 per cent digital, as their business models rely on the infrastructure and the development of the digital economy.

While in the US there are global players such as Google or Amazon, in Europe companies are mainly young and small in size, operating in niche markets, which present sales growth and higher operating margin features. However, due to their scarcity, market valuations of the ones listed tend to be high. For this reason, attractive stocks are found in the second stage, where traditional companies need to adapt their business models. This is a risk for those that will lag behind, but also a great opportunity for the winners, says Mr Maillot.

Artemis also invests in an “ecommerce and digital” theme, with Google being the biggest stock holding of its global thematic equity fund. With the number of smart phones increasing in the world, more and more people will use the search engine, and more frequently, and Google will profit from location-based and banner advertising. “Google is a classic stock for us: highly cash generative, very high barriers to entry and good long-term following winds,” says Artemis’ Mr Edelsten.

Another way to invest into this theme is though software companies which analyse data for large online businesses. Their role is to turn all the data online companies gather about their users into customer information for marketing campaigns. While not very well known in Europe yet, this ‘big data’ theme is a relatively hot theme in the US, he says.

Stocks such as Rakuten, the Japanese ecommerce and internet company, and Mastercard are also holdings of the Artemis fund. Warehouse companies in countries where ecommerce is strong are attractive too, says Mr Edelsten, as they have very high growth characteristics but are not trading at the very high multiples of companies such as Amazon.

Opportunity set

The theme is the filter but picking stocks is still the core job of a fund manager, says Mr Edelsten, warning against the risk of getting carried away by the theme and become undisciplined on valuation.

Each theme generates an opportunity set that offers a basket of companies to look for, according to Sarasin. For example one of the effects of the growth of emerging market middle class is the change of their diets: people eat more dairy-related produce than ever before in Asia, and drink more Coca-Cola than water in Mexico. These developments may have side effects on health, and dietary changes bring an inevitable need to raise agricultural yield, as the population gets bigger. The analysis of the opportunity set opens up new investment opportunities.

In order to be attractive, the stocks relevant to that opportunity set need to display at least one of the five key thematic drivers, which are believed to be the “real catalysts for the rerating of the share price,” according to Sarasin.

These are: 1) ‘security of supply’, which indicates a company having the security of the supply chain, 2) ‘disruption and innovation’ – Amazon is a typical example of a company that disrupted the way people shop, 3) ‘corporate restructuring’, where for instance a management change may become the reason to own a company, 4) ‘franchise power’, when a company demonstrates to have the ownership of the franchise and is generally price setter rather than price taker, and 5) ‘strong get stronger’, which identifies companies that do not need government intervention, are able to borrow money freely in the credit market, have very strong balance sheets, and are generally global leaders in their field.

While the investment process might be different, the end result is the selection of “good high quality, global blue chip structurally growing companies,” says Sarasin’s Mr Jeffries.

However, in general thematic funds such as those related to water scarcity or clean energy, tend to be considered niche products, used in the satellite part of the portfolio, often incorporating an ethical or responsible investing component, meeting investors’ increasing interest in this area.

“Thematic funds target narrowly defined niches, but they do have some appeal for clients,” says Yves Bonzon, CIO of Pictet Wealth Management, mentioning for example the biotech fund as one of the latest themes perceived as hot by clients, but he has doubts about its attractiveness today due to high valuations.

UBS and Credit Suisse have a more positive view on thematic investments. Particularly in the equity space, they enable investors to get exposure to growth and excitement around developments and innovation, states Bill O’Neill, head of CIO Research UK at UBS Wealth Management. Rather than a country by country or sector approach, thematic investments such as global financials or the Asian consumer are seen as “a better way of capturing opportunities available on a global basis, investing in companies across sectors and countries”.

Thematic investing though would never be the core of portfolios, but is complementary to the views expressed through the country or sector approach, he says.

The role themes play in a portfolio very much depends on how broad they are, sustains Credit Suisse’s Mr O’ Sullivan, with broad themes such as the emerging consumer generally used in the core part of the portfolio. On the contrary, very niche themes are generally just young themes beginning to grow and take off. Robotics is a good example, but here it is just hard to find a large number of stocks.

Research teams in the investment industry, previously organised on a country and sector basis, are increasingly thematic based.

In general, a thematic approach enables also to isolate the factors driving performance, much more than on a sector basis, and having the value of building a story around it makes the investment more tangible and understandable to clients, explains Mr O’Sullivan.

However, he warns, by the time a theme gains public prominence, it can already be too late for investors. That is why the bank introduced a ‘traffic light system’, where themes still attractive from a valuation perspective are given a green light, and those that may be interesting publicly but are believed to be overvalued have got a red light.