Webinar Replay: Looking Ahead with Thematic Investing
The replay of our webinar, “Looking Ahead with Thematic Investing” is now available. In this webinar, we discuss:
- How to approach thematic investing
- Which themes are poised to disrupt existing sectors
- How to construct a portfolio with thematic ideas
Stephanie: Hello, and welcome to today’s webcast, Looking Ahead with Thematic Investing, sponsored by Global X Funds. Today’s live webcast has been accepted for one CFP, one FEMA, and one CFA/CE credit. For questions on credits, please use the number on your console. A copy of today’s presentation, as well as additional documents can be found in the green folder at the bottom of your screen. We also have a brief survey, which can be accessed from the teal folder. Our speakers will be taking invited questions. Please type your questions in the box to the right of the slides. We’ll get to as many of your questions as possible. If you are interested in a one and one meeting with Global X Funds, please click on the blue One on One folder at the bottom of your screen and confirm the request. A replay of this webcast will be made available. All registers will receive replay information by email after the webcast ends. With that, I’d like to turn it over to today’s first speaker, Jon Maier, Chief Investment Officer for Global X Funds; Jon.
Jon Maier: Thanks, Stephanie. Hi, everyone. Welcome to the call. Today’s topic is Looking Ahead with Thematic Investing. I’m the Chief Investment Officer at Global X. I joined the company about eight months ago. I’m very excited to be here. Global X is an ETF issuer. We’re based in Manhattan. We have 52 ETFs with approximately 8.5 billion dollars in assets and those assets are growing fast. Many investors know our firm for our income suite as well as our thematic ETFs. We have 17 products in the thematic space with about 4 billion dollars in assets under management. Today, as you know, the topic is going to be thematic investing. With that, I’m going to pass it over to the head of our research, Jay Jacobs.
Jay Jacobs: Thanks, Jon. Happy Friday, everyone. I want to start off today talking about thematic investing by putting it in context with some other styles of investing. For many portfolio managers, strategists, there’s a tension between how much should we look at the past to influence our decisions on portfolio construction and how much should we think about the future? I try to set up this dichotomy right now because we’ve obviously seen a huge proliferation of smart beta ETFs in the ETF world. A lot of this is based off of what we’ve learned from the past. It’s looking at things like historical performance and trying to understand what drove that performance. Was it something like a value factor, or a size factor, or momentum and using that information to tilt portfolio exposures to those types of factors to generate performance in the future.
I think – I have plenty of respect for smart beta strategies. I think many of them are very well constructed, but I like to talk about thematic investing. It’s just a very different approach to thinking about returns because, in a sense, it has nothing to do with what we’ve learned in the past. It’s actually looking at the future and saying that perhaps nothing that exists today is going to be the same. That there are going to be disruptive events in the future in technology, in people, and demographics, and consumer behaviors that are different. To the idea behind this is can we adjust our portfolios to try to anticipate these changes perhaps as a compliment to smart beta strategies or to other ideas that are really looking backwards. This is a forward-looking strategy that’s really looking for future growth based off of these anticipated changes that are happening in the world.
With that little intro, I’ll talk a little bit about our agenda for today. I’m going to do an overview of thematic investing. We recently put out a white paper called, Investing in Tomorrow. It’s on our website. I’m going to go through some of the highlights of that white paper that really talk about how we think you should best approach thematic investing. I’ll talk about why now, why we think this is a really important inflection point in the economy and in some of these thematic ideas. Then we’re going to go to three themes that are our most talked about, most interesting themes that we get a lot of questions about, and want to share our key insights in robotics, lithium and battery technology, and the internet of things. Jon is going to talk about how these thematic ideas fit in a portfolio, which I think is a really important idea because thematic doesn’t always fit the grid-like system that Modern Portfolio Theory has resulted in. This will be a really good section. We’ll try to leave a little bit of time at the end for Q&A if we haven’t gone too far in time. If you do have questions, please feel free to use that Q&A box. We will try to get to those. If not during this webinar, hopefully, we can reach out to you afterwards and get to those questions as well. I think we actually have a poll question before we get into our first topic here.
Stephanie: Great, thank you, Jay. Yes, so this is our first polling question of the day. We will have a couple of these throughout today’s webcast. We would love to get your feedback. Please click your answer choices directly on this screen and press submit. The first question is which of the following investment strategies are you currently incorporating in your portfolios? You can select all that apply. Your answer choices are: positioning for a rising rate environment; gaining exposure to disruptive technologies; tilting away from or towards particular geographies given the current geopolitical environment; holding investments that stand to benefit from changing consumption patterns or demographics; or the final answer choice, none of the above. Again, that question: which of the following investment strategies are you currently incorporating in your portfolios? You can select as many that apply. I’ll give you just another moment or two to get your answer choices in. With that, Jay, I’ll go ahead and take it back over to you.
Jay Jacobs: Alright, thanks, Stephanie. We don’t have the answers to that poll question yet. We’ll be looking at the answers of those poll questions at the end of this webinar. While you’re thinking about that question, I want to start from a very high level about what is thematic investing? We define it as the process of identifying macro-level trends and the underlying investments that stand to benefit from the materialization of those trends. It’s really a two-step process. One is ‘what are the themes that we see as being very disruptive in the future?’ Two, ‘what companies are really in the best position to capitalize on those trends?’ The characteristics of this type of investment strategy, we believe it’s much more long-term focused, very much focused in growth. These tend to be unconstrained, meaning that traditional sector classifications and geographic definitions don’t matter as much.
If we’re looking at a theme like robotics, I frankly don’t really care if a robotics company is in Japan, or the United States, or in Europe or if it’s classified as a consumer electronics company or an industrials company. We’re looking for companies that are really in the most – that are operating in the robotics space and are disrupting the existing paradigms. Sectors and geographies do not matter in the way that in traditional portfolio construction they do. Because of that, these strategies tend to have low correlations with other parts of your portfolio. They’re very relatable concepts. That’s one of the things that I enjoy most about thematic investing is that these are fun things to talk about. You can talk about lithium and battery technology with pretty much anyone because people are seeing electric vehicles on the streets, and they’re reading about them in the newspaper, which makes this a very fun and engaging topic.
We often get questions about how we think about thematic investing and what themes we choose to put in the ETF wrapper. It’s actually a very simple answer. It’s a three-step process. One is we try to create a universe of themes. We do a lot of research looking at what are the themes people are talking about across Wall Street, across consulting, in the technology space. We try to get a very broad view of what themes are out there. Then we apply these three tests to them. One is, do we have high conviction in this theme? If you don’t believe the theme is going to happen, then don’t even bother spending time trying to work on an ETF and think about the investment case for it because it’s just too low probability of an event.
The second thing we look at, is it investible? By this, I mean two criteria. One is there a broad set of companies that have exposure to this theme. Especially in the ETF world, you essentially need to have 20 or more companies to be able to launch an ETF. The second thing is, do those companies actually have high exposure to this theme? There might be a theme out there that’s interesting. You can cobble together a list of 20 companies, but at the end of the day, if that is a very small portion of those companies’ revenue, I would say that that is not a lot of exposure to the theme. It’s very tangential. We’re looking for companies that do have higher exposure to those themes. Then the third test is about time horizon. Ideally, these are medium to long, or even evergreen trends because one, from an ETF product construction perspective, it takes a long time to build an ETF in the thematic space. Two, we think it’s a better outcome for investors because the timing becomes less important the longer term it is. If it’s a very short-term theme, you essentially have to nail the timing to be able to extract any outperformance that might come from it. Whereas, if it’s long-term, people have more time to research it, to consider it, to think about how it fits in the portfolio before the theme is over, and if the theme ever does end.
On that note, I want to make a comparison between two different ways people think about thematic investing because we read a lot about the space and we hear people talk about it. The word thematic I think is applied to more types of investing styles than the way that we define it. The way to break this up is into really two different buckets: one is cyclical themes and one is structural themes. If you’re looking at this cyclical space, these are themes that are recurring in short to medium-term intervals. They tend to be mean-reverting. You’re seeing the ups and downs throughout the days, months, or years. This could be, where are you in the business cycle? Where are interest rates? Looking at volatility, currency values, things like that; these tend to fluctuate up and down. If you are a great portfolio manager or a great investor, you can certainly play those cyclical themes to your advantage if you can enter at the right time and exit at the right time, but these tend to be mean-reverting and they tend to be shorter in nature.
What we like to focus on are the structural themes. These are the longer-term themes that are not mean-reverting. They tend to be almost one directional in their progression. That’s not saying anything about the returns, but what I mean by that is, if you look at technology, it tends to pretty much only get better over time. There’s no mean-reversion in technological advancements. It just tends to improve and compound over time. When we look at structural trends, we’re really looking at the right side of this page, not the cyclical themes that are coming and going. Jon, I wanted to loop you in here as a portfolio manager and CIO, how do you think most people are looking at thematic investing? Do you see one of these as being more common than the other?
Jon Maier: I think that people – in terms of portfolios – there’s two parts to a portfolio. As Jay talked about, a lot of the thematic ideas are structural changes that are forward-looking. But a lot of portfolio managers tend to take their cues from the past. They look at the current market, volatility, where do they think interest rates are going, what type of cycles we’ve seen in the past, policy. In terms of setting the allocations, a lot of those inputs, those market assumptions, really have been derived from the past. What’s very interesting about the concept of thematic investing is there’s nothing really to look at in the past because it’s really disrupting and changing something that is already there. That’s how I think the theme should be looked at and viewed.
Jay Jacobs: Got it. I want people to hold on to that. If you look at the chart in the middle of the page, you see the shape of that structural trend as being that S-curve. I want you to hold onto that because on the next slide, we’re going to talk a little bit more about that shape.
What we’ve seen in the past is this idea of The Diffusion of Innovation Theory, which is that most new ideas, technologies follow this S-curve shape of adoption over time. That there’s a slow movement initially of people called innovators who are hopping on a theme, frankly, taking a big risk in the theme. Think about the people that bought electric vehicles in the 1990s. These things were hardly street ready, but there was a small group of people who were really excited about the technology and were really ready to take a gamble on it in a sense. Or think of something like Google Glass, it’s a technology that frankly failed, but there was a group of innovators who were excited about being able to film their lives and implement things like augmented reality. It was just ahead of its time. What tends to happen is when technologies start to break out of that phase and enter into the early adoption phase or even the early maturity, it’s when you see really an acceleration of the adoption of that trend.
We’ve written some blog posts on this concept, but it’s always interesting to see what types of technologies are fitting in the early part of the curve. It really depends on where you sit, but you can look at something like 4K TVs. If you just look at the adoption rate of those, that’s actually probably more in the early adopter’s phase right now. It seems like they’re everywhere. You can’t pick up an electronics flyer in the newspaper that not just selling 4K TVs, but that’s still pretty early in the adoption phase. It’s certainly not ubiquitous. It’s interesting to see the acceleration there.
Then towards the end of the product’s penetration, you start to see that growth slow down. That’s just natural. At some point, everybody has something. I think the latest figures show that about 86% of US adults have a social media account.1 When you think about just strictly the adoption rate, social media it’s certainly in the late majority, if not in the laggard’s phase where really there’s only a small group of people who have not made the plunge into social media yet. That’s not the same as what revenue growth looks like or earnings growth in any of these sectors. This is purely just looking at what percentage of the population own a certain technology.
What I think is useful about looking at this S-curve is from a thematic investing perspective is that you can kind of get a better sense of how much risk am I taking with this theme because it’s earlier in the S-curve, it’s not as widespread. It’s not a sure thing that this technology will become very prevalent, but that could mean there’s more return in the future. It’s more of a venture-like investment at that point. Whereas, if you invest in a technology that’s really later in the curve, it’s really demonstrated its staying power, it’s had a very high adoption rate – probably less upside at that point because it’s very well adopted at that point. I think it’s just a useful thing for thinking about thematic investing, where in that curve is that technology? If you look historically at the chart in the bottom, you do see that the shapes of those S-curves can be more elongated, or steeper. But a lot of technologies over time have generally followed that type of S-shape.
We come to the “why now?” question within the webinar. Frankly, we just see that we’re really at the beginning of a massive wave of disruption. One we’ve looked at it – and I apologize if this is a little bit blurry on your screen. You can also download the presentation here and it should come out a little less blurry. We’ve looked at a variety of different sectors and tried to line them up with which themes are really disrupting those sectors. We started calling it “sector disruptors.” The idea is within a lot of sectors in the economy, we’re seeing very powerful structural themes that are starting to disrupt them.
If you look at the industrial space, it’s really the manufacturing sector. There’s a huge amount of potential disruption coming from robotics and artificial intelligence because we could be in a world 10 or 20 years from now where the majority of manufacturing is automated. Or you can look at the energy sector. We’re still very early on in the adoption of electric vehicles, but you have an entire sector that’s built around the extraction, and sale, and transportation of fossil fuels. That can completely change over the next decade if you see renewable energy really start to take hold and people instead of driving gas-powered cars are using electric. That’s a sector that right now has a lot of risk that is not going to show up in traditional financial metrics. Again, if we think about looking at the past versus looking at the future, electric vehicle risk is very minimally priced in any sort of energy sector right now, but that doesn’t mean that risk doesn’t exist.
Another one to look at, the financial sector. There’s a ton of disruption happening in the FinTech space where new technologies, new softwares are coming out that are either disrupting the norm, such as peer to peer lending, where it’s disintermediating banks from the whole lending process, or that are changing the way banks conduct business, such as new software that’s automating portions of analysis, or clearing, or things like that. I just want to point out one more. The health care space is a place that’s ripe with destruction right now. One of the most powerful trends we see in that space is the movement towards health and wellness. We have lived in a world where if you are sick, you go to the doctor. The doctor prescribes something or gives you treatment to treat that sickness. What we’re seeing become more and more powerful, not just in the United States, but around the world, is people taking a proactive look at their health: eating better food, getting better exercise, going to the gym, monitoring their health with health monitors or wearables, and things like that. Really not waiting for a problem to occur but trying to prevent a problem from ever happening. That in itself doesn’t mean health insurance companies are going away, but it could very much change the health model around the world going forward. I think that brings us to our next poll.
Stephanie: Great, thank you, Jay. The next polling question is how early or late do you think we are in the robotics and AI theme? Your answer choices are: early, working maybe first or second inning; middle, third through fifth inning; late, sixth or seventh inning; or almost over, eighth or ninth inning. Again, how early or late do you think we are in the robotics and AI theme? You can click your answer choices directly on the screen and press submit. I’ll give you just another couple of moments to get your answers in and selected. It could be early, middle, late, or almost over. With that, Jay, I’ll go ahead and take it back over to you.
Jay Jacobs: Great, thank you, Stephanie. We finished out the first few parts of the webinar already. If you guys have more questions about really the approach to thematic investing, I really would direct people to our white paper on our website, which really goes into more in-depth about how we think about thematic investing from a very high level. Right now, we’re going to pivot a little bit and go into more specific themes: robotics and artificial intelligence, lithium and battery technology, and the internet of things, and talk about what’s happening within those themes more specifically before transitioning over to the portfolio implications of thematic investing.
Kicking it off, robotics and artificial intelligence. Frankly, you can think about this as one theme or two themes that are very closely related. I think about robotics and artificial intelligence as really one in the same thing because robotics is the machine body and artificial intelligence is the machine’s mind. What’s really driving this technology forward right now is those things coming together. On the one hand, you see mechanical engineering getting better and better. Things like advanced materials making robots more dexterous, and softer, and more malleable than they’ve been before. Then you have artificial intelligence coming in that’s making robots smarter than ever before. This completely changes how robots are able to function.
Robotics has really been around since the 1970s with what’s been called pick and place robots, where it’s a very large mechanical robot that can be programmed to pick up a piece of sheet metal in one place and to put it down in a second place. There’s no deviating from that plan. If someone gets in the way of that robot, it is going to get knocked over on the way of the piece of sheet metal moving from point A to point B. If that sheet metal is not in the right place on the pick-up, it’s probably not going to get picked up and not make it to point B. It was very rudimentary approach to robotics in the beginning.
Now, we’re seeing that that’s completely changing. We’re seeing robots that are now aware of their surroundings in what’s called computer vision, they’re able to see what’s around them including where are they in the warehouse; what aisle are they on; what are they looking for; where can they find it; as well as to operate around human beings without risk of injury. This is the term cobots that we’re hearing more and more, collaborative robots. A lot of that is being enabled, one, from the artificial intelligence perspective of robots being smarter than ever before, but two, on that mechanical engineering side as well, making things like soft joints in robots, so that they can’t pinch someone by accident and things like that. We’re seeing really an acceleration in this trend that’s frankly been around a lot longer than I think people give it credit for.
There’s really three main reasons outside of those technological improvements that are driving this forward. I realize that a lot of the discussion in the United States is about what is the impact of robotics on the labor force. In other countries like Japan, the conversation is actually completely flipped. It’s about what’s going to happen to our labor force without robotics. In Japan, by 2060, their working population is going to be half the size of what it was in its peak. Suddenly, you just have a shortage of people needed to work certain jobs in retail, in health care, in transportation. Some countries see robotics as a lifeline. That’s what’s really driving some of the accelerated adoption in places where you see aging populations like Japan.
The second reason, which frankly might be a little bit more cynical, is in labor cost savings. The trend in the 1990s and early 2000s was in outsourcing: moving things offshore to cheaper markets where you could pay lower costs for the same type of work. That’s obviously led to a lot of the rise of China and Southeast Asia. Now, what we’re hearing is the concept of no shoring, where that type of labor can happen anywhere – in the United States, in Asia, in Europe – because it can be done by a robot. There’s no reason to incur additional shipping costs if you can have a robot that’s going to cost the same amount of money wherever you buy it and place it. That’s the concept of no shoring and saving further on labor costs. The third aspect is performance improvements. There’s simply no question a robot can work 24 hours, doesn’t require breaks, doesn’t have emotions or need to be managed, and can produce things in a very consistent manner. In certain industries, that’s a very important function of a play.
We’ve talked about the sector disruptor approach and how robotics is really changing the industrial sector. I don’t think it’s really limited to just that space. You see robotics as such a powerful theme that’s it’s impacting all different parts of the economy. Obviously, there’s the manufacturing aspect, but we’re seeing robotics become increasingly used in the military with unmanned vehicles and drones. We’re seeing it used in medicine with surgical robots. In transportation with the growth in autonomous vehicles. Even in areas like agriculture, further extension of autonomous vehicles, and tractors, and areas where they’re able to automate more and more of these functions. While we think about robotics as really focused on the manufacturing space, I simply would not just limit it to that one area.
To dig down a little bit more into the industrial space, we do just want to show some general trends that we’re seeing. Industrial robotics is growing around the world right now, but one of the areas where we’re seeing the biggest growth is in China. Eighty percent of new revenue for Japanese robot manufactures came from China last year because for reasons we just talked about with the low-cost labor. China used to be the cheap outsource option. Now, when you see rising labor costs in China, that’s no longer the case. If you’re looking to offshore, many people are moving to Vietnam, Bangladesh, Pakistan, where there’s cheaper labor costs. China’s not really that low-cost labor source anymore, so they’ve realized they’re way behind in robotics and are aggressively trying to keep up with other parts of the world.
Again, if you think about it, it’s still very early on in that curve. One of the sub-trends we’re seeing within the robotics theme is this very rapid growth out of China.
Jon Maier: Jay, I have a question for you. There’s clearly a use for robots in the industrial space. Japan certainly has a need in a lifeline that’s depending on robots for the future because of their aging population. But thinking to the consumer, does the consumer really need some of these items like robots for kids where you put your hands around them and they move around, or you can operate them on your iPad, or a Roomba, a robotic vacuum.2 Are these necessary? They’re fun to have. Will they really make a dent in the way we live? I hear about machines that will fold your laundry. Yeah, it’s nice to have, but that’s certainly a 1% issue or problem.
Jay Jacobs: It’s a good question. I think what I would want, and what I think most people want, is this idea of a robotic butler. Or this one robot that can come in and do all the task you don’t want to do, whether it’s walking your dog, whether it’s cooking food, whether it’s vacuuming your rug. The reality is it’s very hard for a robot to do all of those things, but any one individual task is actually pretty easy. They have robots that can fold laundry. They have robots that can cook burgers on the grill. They have robots that can – obviously, they have robots that can vacuum floors. That’s been around for a couple of years. I do think from the consumer perspective there’s this question of are people ready to have a closet of robots that can do all these different tasks? I think right now, that just hasn’t been proven out that people want to have this many robots running around their house.
I also think there’s a little bit of fear of just this technology is getting so much better. Why invest in it now? Why not wait a couple of years? The consumer space, I think there’s a little more work that still needs to be done around accepting robots into your daily life. The question is do we need robotics? I think you can certainly assign a value to it. If you’re faced with one vacuum that’s your traditional vacuum, and it costs $200 or a robotic vacuum that will clean your floor just as well for $210, there’s obviously a group of people that will spend the extra $10 to not have to do it. Now, would people spend $50, $100, $200? That’s the question. I think the more robotic costs come down, the more people are going to be interested in having that capability. There’s certainly a value to robotics, but there’s a question of how much value is that, and to what group is that valuable to.
Jon Maier: I’m hoping the robot that shaves my beard for me will be coming out soon.
Jay Jacobs: Alright, switching gears. That’s our first theme. Our second theme we’re going to talk about today is lithium and battery technology. This theme is frankly one that we were a little ahead of the curve on. We thought that lithium was really going to benefit from the rise of consumer electronics: cell phones, tablets, laptops. The reality is an electric vehicle uses about 10,000 times more lithium than a cell phone. The real question here is how much and how quickly are electric vehicles going to start to enter our daily lives because that’s going to have a huge impact on the lithium space and the battery manufacturing space as well. We put this chart up. This is from a lithium producer, so you can take it with a grain of salt. Right now, lithium demand is about 60% driven by nothing related to batteries, essentially industrial uses like greases, lubricants, glass, ceramics. By 2021, people are expecting that 75% of total demand could come from batteries. That’s how disruptive the rise of battery technology could be to the lithium space.
Within the lithium space, it’s a very concentrated group of miners and producers that are involved. Some people like to call it the lithium cartel, which is a little bit cynical, but it is somewhat related to what you see in OPEC in the oil space, which is so much of the production is concentrated in just a few names that if people think about growth in the lithium space, they really need to understand how are these miners going to react. Are they going to put more supply on the market to meet rising demand? Are they going to pull back a little bit and try to let demand just run wild and let lithium prices grow aggressively? In the others bucket, that other 14%, how aggressively are other people get into this space and try to disrupt that because we certainly see companies that are in Nevada, and Australia, and in Canada that are actively looking at the lithium space because they’re seeing a metal that previously wasn’t economical suddenly become a lot more attractive as prices start to rise. For now, a big portion of the lithium market is controlled by a very small group of companies.
There’s really two things that are going to be driving electric vehicles going forward. I think it comes down to economics and regulation. You could probably apply that to most themes. On the economic side, the trend that we’re seeing right now is rapidly falling battery prices. From 2014 to 2016, over the course of just three years, battery costs fell by half. If you see the orange line at the bottom there, that’s essentially the estimated cost of how much an internal combustion vehicle is relative to an electric vehicle. The idea here is if battery costs can get below $100 per kilowatt-hour, then suddenly electric vehicles will be more economical than an internal combustion engine. Right now, we’re seeing them converge. Electric vehicles are still more expensive, but you do see some regulatory action on the other side of the equation, which is helping to propel this along, even if it’s more expensive.
You do see some very large car markets like China starting to put in regulation to essentially spur the growth of electric vehicles. By 2019, China’s going to force 10% of their vehicles to be hybrid or electric. In Norway, by 2025 all cars have to have zero emissions. Forty percent of all car sales in Norway last year were electric or hybrid. Other markets like India, the UK, and France have also come out with similar regulations. Then you’re even seeing in certain cities that have been suffering from so much air pollution, that they’re putting in regulations about what kind of cars can be on the road, whether it’s hybrid or fully electric. There’s a lot of momentum on the regulatory side for electric vehicles right now.
Here’s a chart that I was eluding to earlier. The number of grams per type of product in terms of how much the lithium usage is. Smart phone, you can see it scale up pretty quickly. Hybrids and electric vehicles just use so much more lithium than consumer electronics. We did a little bit of the back of the napkin math, and it would take about a million electric cars to equal all of the lithium consumed by smart phones in the world. Frankly, we saw about half of that subscribe to the Model 3, so that’s certainly going to be succeeded pretty quickly.3 When you see different penetration rates on the right-hand side, you just see how many more multiples of lithium will need to be supplied over the next couple of decades to meet demands for future lithium supply.
The real question is, are the car manufactures doing anything about this because we’ve seen different car manufacturers try to enter the electric vehicle space with varying degrees of success. It really seems unlikely that electric vehicles can be ubiquitous without buy in from some of the biggest manufacturers in the world, which are going to have the lowest manufacturing costs and things like that. Frankly, what we’re seeing across the board is a pretty strong reception from the automobile community. Now, some automobile manufacturers I think are looking at this opportunistically and saying this is our chance to capture market share and to do something differently. Others are doing this reluctantly because they are so bought into the internal combustion engine world that this is a big pivot for them. You really see across the board, virtually all of the major automobile manufacturers making some level of commitments to either building from one extreme making their entire fleet hybrid or electric to the other extreme, just offering hybrid and electric variance of existing models. You are seeing pretty strong buy-in from across the automobile industry right now.
Jon Maier: Jay, how do you effectively come up with a product to capture the lithium theme? There’s so many different aspects. There’s producing lithium. There’s electric batteries. There’s the automation part of the cars, and smart phones, and tablets. How do you bring that all together in one product?
Jay Jacobs: It really goes back to our first slide, which was the top down, bottom up process. When we first identified the theme of the increasing use of batteries and the belief that that was really going to be a powerful theme going forward, the next question is which companies stand to benefit from that? There’s a lot of research and work that goes into that from the research team, from the product development team. You start to get a sense of who’s really involved in that. From the most upstream perspective, lithium miners and producers are in a very great position to benefit from that because they’re extracting the natural resource, which means if the price of it goes up, they can increase their revenues, or if the production of it goes up, they can increase their revenues. They’re really very closely tied to this theme. The second aspect is battery producers, which wouldn’t benefit really at all from an increase in price of lithium, but just an overall increased use of batteries is right in their wheelhouse. We identified those two subgroups as really the best position to benefit from the rise of battery usage, whether it’s in phones, tablets, laptops, or electric vehicles. Then really crafted a product around that that gives exposure to those types of firms. Alright, Stephanie, we have the third poll. Sorry for talking over the slide too long.
Stephanie: No problem at all. Yes, the third poll should be showing on your screen now. If you haven’t had the chance to answer it, the question is which of the following internet of things devices do you find the most useful? Select all that apply. Your choices are smart home speakers/personal assistant such as Alexa, Siri, Google Home. Your next answer choice: smart lights; smart outlets; smart thermostats; or your final answer choice is not sure. Again, that question: which of the following internet of things devices do you find the most useful? You can select all that apply. If you find them all useful, please, by all means, let us know. Just select your answer choices on the screen and press submit. Jay,that might have given them enough time if you want to go ahead and continue on.
Jay Jacobs: Thanks, Stephanie. Alright, this brings to our third and last theme for the day before turning it over to Jon on the portfolio side. This is the internet of things. This is a term that gets thrown around a lot, but we want to specifically define it as the process of taking – and sometimes I hate saying this because it sounds derogatory – but taking dumb objects and making them smart. Meaning, taking objects that exist in our world today that are not connected to the internet, that are not collecting data, and bringing them into a network, making them smart so they can provide some sort of smarter function. You can apply this to such a wide range of products.
I think one of my favorites is talking about a trash can in the city, which is potentially the most basic form of any technology that’s ever been created. Just creating a trashcan and putting it on the corner. What you see with the internet of things is that can actually become a much more efficient process in the collection and disposal of that waste. The old way, you have a trash collector that goes around the city, and on a regular time comes around and picks up the trash and takes it. Now, sometimes that trash can is full and sometimes it’s empty. That’s not going to alter the course of that trash collector. With the internet of things, that’s information that could be relayed back to dispatch. You ideally don’t have overflowing trash cans and you don’t have collections coming around when they don’t need to. You’re taking such a rudimentary process and making it smarter. Then you can apply that to so many different types of applications whether it’s in your house, the way that you heat it and cool it, so it’s more associated with when you’re there, and what the temperature is, and what your preferences are. The lighting or security cameras in your house. All of these things are baseline technologies that are getting smarter.
What’s really driving the growing of this theme? Again, falling costs. The chips that are able to connect things to the internet and the sensors that are collecting that data are getting cheaper than ever before. We’re seeing improvements in internet technology. 4G was a big leap for the transmission of data. 5G could be an even bigger accelerant here as it just becomes easier and faster to transmit huge amounts of data across the network.
We are seeing stronger consumer demand. Jon, you were asking about, do we need robots. I think you could ask the same question about some these smart home things. I don’t know if everybody needs some of the products that are coming out. I was at the consumer electronics show earlier this year. This is a huge push for the consumer electronics industry. They are determined to make everything smart. Frankly, I think some of these things are great to be smart and some of these things might be a little bit pushing the envelope here with what consumers need. There’s certainly a big push in terms of connecting things to the internet. You see that with the growth chart that we put above. A lot of that is coming from really the short and long range of the space, which is really looking at consumer electronics.
Then there’s also the commercial space. The internet of things is actually very closely related to the rise of robotics. Those sensors that are attached to robots that are making them spatially aware that are connecting robots to network, so that they can interact with each other and learn from each other. That’s the internet of things in action. We’re seeing it in health care, and infrastructure, and really across many different sectors.
We talk about that a little bit in some of the other themes that we’re already seeing. In driverless cars, the internet of things plays a really important role in connecting vehicles to a broader network. If we get to this ideal state where you never see traffic anymore because every car can communicate with each other, that’s going to be the internet of things at work. Smart cities, whether it’s a smart trash can or smart infrastructure that’s reducing traffic and reducing waste. That’s the internet of things in action. I think all of you are probably familiar with some level of smart homes making domestic life easier, and as we just touched on, making robots smarter as well. A lot of applications across many different parts of the economy.
Jon, towards your question about lithium. The question is okay, the internet of things sounds like a powerful theme, but which companies seem to benefit from it? The work that we did in constructing our fund SNSR in this space is trying to identify which companies are really closely related to the internet of things and would stand to benefit from the materialization of that theme. We broke it into three different buckets. One is connected device manufacturers. Those are the things that you can buy that are connected to the internet of things, whether it’s a wearable on your wrist or an appliance in your house. That’s the connective device manufacturers. The network providers or services, this is the plumbing that’s connecting that device to the internet to make it smart. The semiconductor manufacturers, that’s actually the technology that’s going into those products. We identified those three categories as really being the companies that are in the best position to benefit from the rise of the internet of things.
Jon Maier: Jay, why do you think certain companies are a better fit than others? I can think of one of the biggest software and hardware companies out there that you would think is an internet of things company, but it doesn’t really get classified as that for the purposes of this product.
Jay Jacobs: The question goes back to where do you draw the lines. I’ll actually go back a few slides. The funny thing is if you take the broadest definition of the internet of things, it includes some things that have just been around for so long that there’s really not a lot of growth left in that space. Even landline phones have been considered the internet of things, almost the original form of the internet of things. But no one’s really expecting huge growth in the landline space. Even in mobile phones, and PCs, and tablets, that’s maybe the internet of things 1.0. Our focus is really on the 2.0. What are the next things that are going to be connected to the internet that aren’t already currently connected? It’s less about a desktop computing company, which of course is part of the internet. It’s a thing, but it’s not really where the growth is. The focus is on the internet of things 2.0 just beyond the computers and phones that have been connected since forever essentially.
That brings us to the conclusion of the three things we wanted to focus on. I wanted to leave us with a thought before I turn it over to Jon, which is that a lot of these themes are happening together, that they’re not happening in isolation. Just like I mentioned that the internet of things is closely related to robotics. We’re seeing that across the thematic space, that these themes are enabling other themes to build and to develop. In some cases, they’re accelerating the growth of other themes. For years, people thought batteries were just really subpar and didn’t provide the power that people wanted.
Now, you’re seeing that start to accelerate. What does that mean for robotics now that robots can be untethered and can be powered by lithium batteries? Robots used to not be non-spatially aware, so what does that mean if the internet of things is now connected to these robots? They can learn faster. They can see things around them. These themes are really starting to converge. I think that’s a really exciting thing that we are seeing in the thematic space. I’ll leave people on that exciting end and I’ll turn it over to Jon to talk more about what this means in a portfolio.
Jon Maier: Thank, Jay. That was really interesting. I actually learned a lot on this call so far. Hopefully, that will help as we build portfolios here at Global X. When I think of portfolios, I think of risk tolerance and time horizon. Where am I in my investing life cycle? Am I young? Am I old? Where would something like this fit into a portfolio?
Now, I think it’s really important that everyone has a core portfolio: stock, bonds, and some cash for times when you need cash. But you also have to think of how things are evolving. We talked about our artificial intelligence, robotics, and the internet of things, and lithium and battery technology. Those are things that are going to be part of our daily lives. They are already part of our daily lives. You also have to remember that some of the companies inside the ETFs can be a little more volatile than say a typical core portfolio. You also have to remember that some of the companies that utilize or evolve in some of these technologies transcends regions or sector classifications. Sometimes they don’t fit neatly in a box, but they are equated to a particular sector that is disrupting a traditional sector.
The way I think of the thematic ideas is that it should be just a subset of your overall core portfolio. It’s hard to say exactly how much it should be of someone’s portfolio because again, it goes back to your risk tolerance, your time horizon. I do think that it’s transgenerational. You have young people, millennials who are very involved in many of the different disruptive technologies. The companies that involve in the sense that they utilize the products. You also have people who have money or are older, who still understand that some of these ideas are disrupting and are structural changes versus something that’s cyclical. That brings you to how do you use these in an overall portfolio? I think that, first of all, you have to decide how much of your portfolio you’re going to use disruptive themes. Second, you have to come up with a weighting scheme that makes sense. A lot of these companies are fast-growing companies. Some may have earnings; some may not. The earnings tend to be low just because of the type of companies they are and how they utilize their cash in the company or the money that they make.
We came up with an idea that you look at the traditional sectors and you look at an idea that’s disrupting that traditional sector. Then you weight it based on the growth rate. A growth rate that makes sense in terms of, should it be one year? Should it be the two-year growth rate? Two years probably takes out some of the noise. In terms of growth numbers, a sales numbers, those sales numbers are somewhat accurate because companies are reporting what their future sales will be. The sell side analyst, those analysts report it into different systems like Bloomberg and FactSet. Companies don’t want to overstate their numbers because if they overstate their numbers and they come out with worse sales numbers, the stock’s going to get hit. We feel like those numbers are fairly accurate. Some weighting scheme based on two-year consensus forward sales growth makes a lot of sense to us. I really think that – and I really believe this. In my prior life, I wouldn’t necessarily say thematic investing, but maybe subsector investing, which is kind of on the lines of thematic investing for a certain percentage of moderate and aggressive portfolios. I am a big believer and I think it makes a lot of sense. Pass it back to Jay.
Jay Jacobs: Alright, so before we start to wrap things up, Global X does have a suite different thematic ETFs, five in our technology suite. We covered three of those today. We also have our people related suite, which is based off of the changing demographics and spending habits of people around the world, as well as our resources suite. A pretty broad suite in the thematic space. I saw one of the questions that came in already was what are you adding to the suite? I would love to talk about that. I can’t, but if you do come back to our website, I’m sure you’ll continue to see more themes start to be added as well. With that, I’ll turn it back to Stephanie and we can go through some poll results.
Stephanie: Great, thank you. Yes, the first polling question is on your screen now. The results came back for which of the following investment strategies are you currently incorporating in your portfolio. Looks like the very first one, positioning for rising rate environment was what they’re currently incorporating. The next two, they actually tied right on the dot: gaining exposure to disruptive technologies and holding investments that stand to benefit from changing consumption patterns or demographics. Then final is tilting away from or towards particular geographies given the current geopolitical environment. Jay, Jon, do you guys have any thoughts on how these results came back?
Jay Jacobs: Yeah, this is great because it speaks to one of the earlier slides we were talking about, which is those cyclical versus structural themes. If we think about a rise interesting rate environment, interest rate cycles could be pretty long, but it’s something that we see as being more cyclical than structural. It’s interesting because I do think that these cyclical themes tend to be more popular among portfolio managers, specifically the economic ones because it’s always in the news and people are talking about it. The structural ones are the ones that we have been a little bit more focused on today, such as the gaining exposure to disruptive technologies or the change in consumption patterns. You have number two?
Stephanie: Great, let’s see. Great, yes. Okay, most people are thinking that it’s in the early or middle stages of where we are with robotics and AI themes. I imagine you guys have probably seen similar trend with your clients?
Jay Jacobs: Yep, so I guess people haven’t seen the robot takeover happen yet. We think it is very early still, just given that robotic penetration rate that we were talking about. Really at the high end is just 5% and at the average is around 2%. I certainly think this is still just the beginning of robotic technology and the role that it can play in our lives go forward.
Stephanie: Very good. Looking at the third question, which was which of the following internet of things devices do you find the most useful? Looks like 45% the smart thermostats; 43% said smart home speakers/personal assistant. Then you had smart lights. A handful of people say not sure. Then smart outlets.
Jon Maier: Jay, would you say this is early to mid-adoption in terms of the certain things earlier adopters, mid stage, late stage?
Jay Jacobs: I think all of these are pretty early. I honestly have no skin in the game on this question. I was just curious what people thought. Myself, I have a home speaker. That’s pretty much it because I live in an apartment in New York. I haven’t invested a thermostat there. Jon, what about yourself? What kind of things do you own?
Jon Maier: I have a Nest. I have a Roomba and automated lights. They’re fun things to have. They’re certainly not necessary. I think over time, it’s just going to be part of our everyday.
Jay Jacobs: Alright.
Stephanie: Great, and I’ll touch on just a couple reminders before we jump into Q&A. I know we’re running at the top of the hour. I did want to remind you all a copy of today’s presentation as well as additional documents can be found in that green folder at the bottom of your screen. We do appreciate your feedback. Please make sure you take a moment or two to fill out our brief survey located in the teal folder. Then we also have that one on one meeting request located blue folder also at the bottom of your screen in case you’d like to have a conversation with Global X to further discuss the ideas that were covered during today’s event. Jay and Jon are going to try and get to as many questions as they can. If they are not able to reply back to your question today on today’s webcast, a member of their team will reach out to you directly. You can submit those questions by typing them into the box to the right of your slide. With that, Jay and Jon, I’ll turn it back over to you to take a couple of questions.
Jay Jacobs: Alright, thank you. We’ll take a couple here. We know it’s a Friday afternoon. We don’t want to keep people too long, but we will try to get through a couple of these. Hopefully, we can reach out individually too to answer the ones we can’t get to. First one, Jon, I’ll throw this your way. Wouldn’t an investor already have an allocation to these thematic ideas just through a diversified portfolio, such as through broad US market or a tech fund?
Jon Maier: I would say no. Some of the beauty of these funds, the fact that they’re more focused, more concentrated on these developing themes. If you buy some of the larger companies that have components of what we deem disruptive technology, it’ll tend to be a smaller portion of their overall revenue. By focusing on one of ours or others, ETFs in one of these spaces, you’re getting that concentrated exposure versus just perhaps at the minimum amount of exposure. I think that’s really the difference.
Jay Jacobs: Alright, I’m going turn this one into a two-part question. First is, what advantage do you think the ETF vehicle offers for thematic investing. Then the second part is versus a mutual fund. I’ll take on the first part of why I think an ETF is a good vehicle for thematic investing. Then Jon, maybe you can just talk about ETFs versus mutual funds. If you think about the process of thematic investing, and we’ve hit on this a few times on this call already, is you have to identify the theme. Then you have to identify the companies that you think will stand to benefit from that theme.
I think perhaps the easier part is researching the themes themselves. Obviously, we do some of that work with the choices that we make and what themes we do launch. The second part of identifying the companies then gaining access to them is really I think a challenge for many investors who don’t have a lot of resources. One, just doing that bottom-up analysis of which companies are involved in robotic spaces is tough. That’s hard to do. That’s hard to do globally. Even if you can do that, are you able to efficiently get exposure to those companies to trade in international markets? Seventy percent of our robotics fund is outside the United States. Simply trying to do that on one’s own I think is very challenging. If people do try to do it on their own, I think they’re probably only gaining access to a couple of companies in this space and not really the broader portion of the space. Jon, within the context of an ETF versus a mutual fund.
Jon Maier: You’re getting that great diversification, which you could get in a mutual fund as well. Some of the reasons that ETFs have been widely adopted and the assets have been growing as a percentage much more actually have been grown, where mutual funds have not been growing even though the base for mutual funds is much larger, has been to a few things. Tax efficiency of the structure. They typically don’t pay capital gains. It’s not 100% guarantee that they won’t, but when they do, they tend to be smaller as well. This is accomplished through the in-kind transfer option feature of ETFs. As well as there’s an amount of internal portfolio management that occurs to manage the gains and losses.* Overall fees tend to be lower. There’s approximately 2,000 ETFs listed in the US. A bit under 4 trillion dollars in assets. ETFs are now covering both broad sectors as well as sub-sub-sub-sub-sub sectors, themes, ideas, concepts. They’re not all passively managed. There are some actively managed ETFs out there. There’s different weighting schemes out there. They trade during the day, which may or may not be useful to some, but many people like it.
(*Note: Not all ETFs conduct in-kind transactions. Mutual funds also engage in certain portfolio management strategies to reduce capital gains distributions.)
Jay Jacobs: Alright, next question. Are there VC or private equity positions in the portfolio? This is pretty simple. In an ETF, you have to invest in publicly listed equities. There are no private companies held in the fund. I think that just has to be an accepted reality within the thematic space. If you think about a theme like robotics, you’re going to have publicly traded companies that are involved in the robotic space. You can have private companies. You can have very small startups. There’s even government research in the space.
Those portions, the government portions, the small startups, the private companies, won’t be a part of it. That’s simply the nature of any public equity-based investing in the thematic space. It’s really limited to just what’s publicly listed. The companies that you do get tend to be very innovative. That’s what I love about something like the robotics space. Some of these companies have been around for decades and they’re still at the forefront the robotics theme. It’s really impossible to try and capture the entire theme when you’re looking at the private markets as well. But the companies that we do own tend to be very forward-looking.
Alright, then we’ll do one more question as we’re over time here. How do you think about performance for thematic investing? I’m going to pivot a little bit on this one because I think this is more of a relative question. It’s very hard to benchmark thematic investing. Just sticking with the robotics theme, what’s the appropriate benchmark? Is it MSCI ACWI because it’s a global fund? Is it a global industrials fund because that’s the sector disruptor? Is it just an absolute return benchmark? It’s very hard to say.
What we do think is that these are growth-oriented strategies that are long-term in nature. Trying to benchmark it to something specifically is a bit of a challenge. It’s all about your own expectations. If you’re looking for longer-term returns, you can try to benchmark that versus what are your absolute return expectations for the broader equity markets, something along those lines. You could try to benchmark it versus a global industrials fund if you expect robotics to do better than broader industrials over the long-term. That is part of the challenge. I think, Jon, part of what you talked about in terms of how does it fit in a portfolio? That goes along with it. You do need to accept a certain amount of tracking error and volatility versus these very clean cut geographic and sector definitions that might be in the rest of your portfolio.
Jon Maier: Remember, if you use it in a processed way as a portion of your overall portfolio, your overall tracking error will tick up a bit, but it’s certainly manageable.
Jay Jacobs: Alright, that’s our last question for the day. Thank you, everybody, for sticking on here and listening to us. If you are interested in learning more about the thematic space, I do encourage you do go to our website. Globalxfunds.com/research will get you to our research page, which includes our latest white paper, as well as our ongoing research on the thematic space. Thank you, everyone, for your time. Looking forward to speaking with all of you again.
Jon Maier: Thanks, everyone.
