Be prepared to drop a theme
Themes wax and wane. We have dropped a couple in recent years. One relied on the spending power of the ageing demographic in Western economies. The rationale was that in an ageing world the cohort of new pensioners was growing at a faster rate than GDP. However, there reached a point when the bulge of retiring baby boomers started to thin. As people move further into retirement they tend to spend less. It was time to move on. More recently we had a tourism theme, designed to benefit from the growth in international travel. Early last year we decided that the strengthening green agenda might act as a brake on air travel and exited in time to avoid the carnage caused by Covid.
There is little point investing in any business if it is facing mounting environmental, social and governance issues. We monitor these continuously as they can change over time. For instance, we expect the new Democrat Congress to set higher regulatory standards for online media businesses. This could prove expensive for companies like Facebook (where we also have governance concerns).
Watch valuations and vary the allocation
When a theme becomes popular valuations can soar. This may be good for a while, but what goes up too far always comes down. We can vary the amount invested in each theme as valuation dictates. The ability to increase or decrease capital in a theme helps in other ways too.
At the start of 2020, we expected a steadily growing world economy led by the US. This would have suited our automation theme, for instance. When the pandemic struck we reviewed our themes swiftly. It became clear there would be sharp economic contraction in the US and Europe so we reduced our exposure to the more cyclical elements in our portfolio, focusing more on holdings in “online services” that could help us work from home and our “scientific equipment” companies that lead the world in testing for Covid-19. With the arrival of vaccines suggesting more normal social conditions later this year, we have again reviewed our themes, taking some profits in our technology holdings. We have added to the more economically cyclical themes, like “automation”, which should see rising orders as economies recover and economic stimulus measures come through.
As illustrated here, the benefit of a diversified portfolio built around themes is that we can switch emphasis between them when circumstances change or the market cycle turns. But that means we have to choose themes carefully, ensuring they are not too heavily correlated.
Thematic investing can work
Undiversified single-theme funds in segments the market has most favoured will often top the tables of annual performance. Holders of these funds will speak eloquently at drinks parties (remember those?). However, it is the average of fund performances which tells the whole story.