The Risk-Based Argument for Thematic Investing

Many consider thematic investing to be a growth-oriented strategy, seeking to benefit from the emergence of powerful structural trends. For example, investors may seek exposure to disruptive technologies like robotics and artificial intelligence because they believe it has a high likelihood of disrupting a variety of sectors and, in turn, experiencing rapid growth. Yet investors may also view thematic investing through the lens of potential risk reduction- not necessarily through traditional financial risk metrics like volatility and drawdowns, but as a method for hedging against long term external risks.

To illustrate this point, consider a pension plan for employees of an oil company. The pension plan depends on annual contributions from its sponsor, the oil company, to fund its obligations. If oil prices fall meaningfully, the sponsor could face financial stress, and contributions risk being cut. Therefore the pension plan inherently has risks associated with oil prices. As a result, a fund may actively look for ways to hedge the risk of an oil decline. One approach could be to take short positions in oil futures, which could mitigate the impact of a near-term oil price decline. But given the long time horizons of most pension funds, the plan may also want to hedge against a longer term, secular oil price decline. One possible solution is to invest thematically in emerging technologies or materials that pose an existential threat to oil, like the rise of renewable energy sources or lithium and battery technology. This is in fact a tactic employed by Norway’s sovereign wealth fund. Because it depends heavily on oil revenues, the fund’s managers announced that they would “roughly double its environmentally related investments… [including] companies active in renewable energy, energy efficiency, pollution control.”1 By investing in these themes, the fund managers hope to position the fund for an era where renewables could replace oil as the world’s premier energy source.

These same principals can apply to individual investors when one considers the question: “what are the risks to my future financial well-being?” While there are dozens of possible answers ranging from an economic downturn, to personal health issues, or natural disasters, few of these risks can be effectively mitigated over the long term. Yet there are certain risks that could be. For example, people who work in a job that is at high risk of automation face a potential threat to their future income because of advancements in robotics and artificial intelligence. Rather than allowing this risk to remain unaddressed, they could attempt to mitigate this risk by investing in companies that stand to benefit from the rise of these technologies.

From another perspective, a couple close to retirement could be concerned about longevity risk, or the risk of outliving their savings. This risk may be particularly acute given rapidly rising health care costs and uncertainty around potential changes in health care policy. In an effort to hedge this risk, the couple may consider investing in companies that should be well-positioned to benefit from the trend of people living longer around the world. This way, if health care costs rise and average lifespans continue to increase, the couple may realize some benefit through stock price appreciation of these longevity-related companies.

While thematic investing is not a perfect hedge, it may serve as a useful counterweight to some of the longer term risks certain investors face. Given the rapid rate of technological advances, uncertainty around government policy, and concern about the future availability of natural resources, we believe investors could be well-suited to consider thematic investing as a means for positioning a portfolio to potentially benefit from these rise of these disruptive themes.