Quintet 3-year-thematic: Why zooming out is also important

Our thematic investing approach involves gaining exposure to companies and themes that benefit from major global trends over the long term. This means gaining exposure to the drivers of megatrends, such as demographics, energy transition or geopolitics. Investments, therefore, could be in areas where there are big shifts due to evolving technologies or changing demand patterns.

The financial markets focus mostly on short-term trends – what will central bankers say next week, what will the inflation print be next month, or what will the next quarterly earnings season mean for markets? Using our thematic investing approach, we zoom out from short-term news flow and focus on the bigger trends in the world in order to form investment frameworks on a medium-to-long-term time horizon. In this research update, we present our latest thematic outlook for the next 3 years.

Eyes on the future…

We believe innovation is likely to continue apace in the long term. Our thematic investing approach prefers so-called “S-curve” themes. This is where technologies and business models are already established but may still be a long way from widespread adoption, growth and value creation, for example cloud computing. Most companies involved in S-curve themes are able to invest in innovation to build better products, services and stronger ecosystems.

…but mindful of the present

However, after almost 15 years of exceptionally low interest rates, the economic backdrop has changed materially since 2022 due to higher inflation, post-COVID shifts and the war in Ukraine. We are now in a phase of higher cost of capital, many unprofitable themes and rise of risks like geopolitics, de-globalisation and demographic challenges.

While thematic investors ought to consider exposure to technologies of the future, it’s important not to lose sight of the fundamentals. In the near term, we believe there should also be a strong focus on companies with strength in time-honoured metrics (such as a robust balance sheet) and better resilience in the face of challenging economic backdrops. The recent stress in the US banking sector, due to the collapse of Silicon Valley Bank, is a reminder of the risks that companies with weaker fundamentals face when conditions deteriorate.

A NEW NORMAL BY 2025

After a major expansion in the money supply post-pandemic and a strong rebound in 2021, we have been in a less exuberant global backdrop since 2022. While China is already picking up, much of the rest of the world could be in a “reset” year during 2023 as economies, companies and consumers adjust to volatile markets, less buoyant economic conditions and changing spending patterns. Thereafter, the possibility of a mild and less tentative recovery in 2024 emerges. By 2025, we could reach a new normal where, while some pressures remain due to persistent global issues, innovations and a new long-term cycle point to a rosier outlook. We believe three aspects will drive this journey in financial markets, some of which are already in motion:

Activity: Firstly, when we think of activity levels, we are in a sluggish global economy going from a mild slowdown in the near term to a mild recovery by 2024, and towards normalisation by 2025. This normalisation can then lead to improved activity levels and a new cycle of growth.
Policy: Secondly, the restrictive interest rate environment seen in the past year subsides, innovation can once again accelerate. Nevertheless, the monetary policy backdrop to 2025 may still be less exuberant compared to the post-2008 era, given the resurgence of high inflation after many decades and fears of its persistence among policymakers.
Confidence: Finally, we also think of confidence levels – as money supply remains tighter than in recent years, we expect some austerity by consumers and corporates in the near term, followed by recovery in 2024 and normalisation as we reach 2025. If confidence levels improve by 2025, we believe consumers and corporates ought to become more open to taking risks and driving innovation.

KEY THEMATIC TOPICS BY 2025

Understanding the topics that may become key discussion points by 2025 is important, irrespective of current macro events. These topics are likely to influence the path to 2025 and beyond, presenting both opportunities and risks for the long term:

People: We believe that ageing populations are set to become a very important trend for the next decade and beyond. Recently, China’s population declined for the first time in 60 years while availability of workers remains low in western countries. For example, in the US, there have been approximately two job openings for every unemployed person for some time now. Ageing demographics can drive healthcare demand but also influence labour supply. This could lead to wage pressures, inflationary pressures and dislocations such as industrial strikes.
Planet: We believe the climate change theme will continue to gain importance in the long term. The new aspects in the climate change and energy transition debate, influenced by the war in Ukraine, are energy independence and energy security, both becoming critical considerations. Policy is also gradually shifting towards more sustainable investments (e.g. European regulations) or green technologies (e.g. support from the US Inflation Reduction Act). Clean technologies themselves are improving rapidly across multiple markets and sectors.
Productivity: Perhaps the trend grabbing most headlines recently is Artificial Intelligence (AI). A perfect example is the launch of ChatGPT, which became the fastest adopted product in history reaching 100 million users in just two months. While there is clearly a lot of hype around AI for the time being, the long-term opportunities could be immense for productivity. Robotics, automation, and cloud computing are major trends that are supported by worker shortages, cost pressures, and the need to improve productivity.

Careful analysis with eyes on future

From an era of “disruptive innovation” where most innovation themes performed well, we believe we are now in a position where the market is likely to also care about the fundamentals. We assess companies within the major themes and megatrends by looking at their quantitative and qualitative aspects. We prefer those themes and megatrends with higher quality companies, where the risks from balance sheets, high expectations or high valuations are less pronounced. Most companies within themes have exposure to future technologies, so by gravitating towards higher quality themes, investors can get exposure to long-term growth and trends while limiting risks.

Our preferred themes

Amid market uncertainties, our preferred themes seek to strike a balance between growth and defensive qualities. Overall, we still see some residual risks to 2023 revenue forecasts of thematic companies but the correction in equity markets and earnings resets since 2022 start to offer some select opportunities for the long term.

PEOPLE	PLANET	PRODUCTIVITY
FUTURE HEALTH	CLEAN ENERGY	CLOUD COMPUTING
ASPIRATION ECONOMY	ELECTRIC VEHICLES	PROCESSING POWER
	WATER & WASTE	ROBOTICS & AUTOMATION

We avoid themes that have high proportion of unprofitable companies, long lead times for innovation or market scaling and saturation emerging in their markets. These themes tend to have more exposure to a weakening consumer and higher risk from early-stage innovations.

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