The pandemic changed everything... and changed everything quickly. It was March 13th of 2020 that the world shut down and a new "normal" was created for how we live, work, travel, shop and learn. Investing in 2020 became defined by themes and, as a result, assets under management (AUM) in thematic funds grew by $72.5 billion in 2020 as retail investors and professionals looked for common sense ways to position their portfolios in these unprecedented times. (1)
The development of Exchange Traded Funds (ETFs) in the 1990s provided the perfect delivery vehicle for investors large and small who wanted easier and quicker exposure to popular themes focused on long-term, societal trends such as disruptive technologies, climate change, or shifting consumer behaviors. (2)
AT WT Wealth Management, we were an early adopter of thematic investing, using thematic ETFs since 2014 to position our clients in areas that we feel will generate above-market returns over the long term. And we continue to believe that the use of themes for navigating different market conditions will be a prominent strategy over the coming decade.
What is Thematic Investing and How is it Different?
But let's first take a step back to define what we're talking about. Thematic investing involves investing in a portfolio that gathers together a collection of companies from certain, specific industries centered around a theme. Typically, themes are well-known and are best characterized as powerful and secular shifts, triggered primarily by new technology, innovation and the resulting consumer adoption. Themes might be based on a concept such as robotics, drone technology, driverless car technology, businesses frequented by millennials or just about any other innovation an investor could imagine. (3)
A key benefit of thematic investing is a less-constrained investment universe. While traditional investing still largely adheres to narrow country boundaries or sector classifications, thematic investors view companies through the prism of either winning or losing regarding their respective theme. This typically fosters a long-term investment approach focused on steady growth and consumer adoption.
With thematic investing, the investor becomes part of the story as they very well could be using and adopting a large percentage of the products and services these companies offer. Investors with strong convictions about the future economic success of a theme (and/or its social or environmental benefits) are able to follow their convictions by channeling their investments.
There were several prominent themes that dramatically outperformed the S&P 500 in 2020, including: cloud computing, work-from-home, shop-from-home, date-from-home and even learn-from-home technologies. Investors in these themes experienced generous returns fueled by rapid revenue growth as a result of widespread consumer adoption of these new and developing innovations.
A number of previously less familiar stocks have now become household names: the video-conferencing company Zoom, dating app Match.com, fitness company Peloton, payment processors PayPal and Square, and document management firm DocuSign – all of which had breakout years in 2020.
For 2021, as a result of the Biden Presidency we have already witnessed substantial dollars flowing into new themes like clean and renewable energy, electric vehicles, battery technology and infrastructure.
Popping the Asset-Bubble Fear
Strong performance often prompts a critical question, and 2021 will be no exception: Is this a bubble? The term "asset bubble" describes instances when broad markets or specific companies reach price levels or valuations driven by irrational sentiments or that become dislocated from realistic expectations of future value.
While many themes significantly outperformed the broad markets in 2020, that doesn't necessarily mean they are overvalued. In fact, many of the best-performing themes posted strong revenue and earnings growth in 2020. Outside of a few outliers, there is little evidence that an asset bubble is a systemic issue based on thematic performance in 2020. That being said, risk remains a core element of any investment approach.
Risks to Watch
At WT Wealth Management, we always try to be cognizant of risks and watch for instances where valuations and expectations become unhinged. After the decoupling of many themes with the broader market in 2020, risk will most likely stem from behavioral or policy catalysts in 2021. Will consumers return to their prior Covid-19 life and abandon work-from-home, workout-from-home, shop-from-home and even streaming entertainment-from-home?
Several themes appear vulnerable to shifts in investor sentiment and behavioral biases. Positive developments on the vaccine front have revived hopes of economic re-openings. The reopening narrative may not adversely impact the long-term expectations of many themes, but investors may temporarily shift their interest to companies that were hard hit by the pandemic and are primed for a rapid earnings rebound. Such a sentiment-based move could produce a short-lived recovery trade followed by a potential return to companies and themes that define how we will live under the new normal.
As we entered 2020, no one predicted, or even imagined, the impact of the coronavirus pandemic. Unforeseen events frequently weigh on the behavior of financial markets, and investors. However, these same unexpected twists also offer opportunities.
While headline economic growth and asset prices often recover from economic shocks rapidly, certain industries like travel or entertainment may be slow to recover or may be structurally and permanently changed going forward. It will take years to understand the full impact of the pandemic.
We still favor post-pandemic companies and feel many people enjoy working, shopping and even learning from home. While many of us can't wait for a mask-free night on the town, a movie or a vacation, the return to normal may be further away than many people realize. Nevertheless, recovery themes have strong potential to outperform.
The long-term prospects across a range of themes tied to technology, demographics and consumer behavior are likely to remain strong. The past twelve months served as validation for many businesses investing in transformational change.
We continue to favor many of the themes that were winners in 2020, but are in the business of tracking changes carefully. The Investment Committee at WT Wealth Management meets twice monthly to discuss where we see the best and most compelling opportunities in a wide range of thematic ETF offerings – both those that were successful during the pandemic and those that will rise to the surface in the post-pandemic world.
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