Why should investors go thematic?
Thematic investing allows investors to focus on the structural changes or themes that will play out over the longer-term, shaping and altering competitive landscapes, but also to look past short-term market or sector noise and uncertainties. Themes have three defining characteristics that makes it appealing to the ordinary investor:
- They offer recognizable signals that make them digestible, recognizable and relatable to investors, and helps them to make investing decisions based on things they know and can observe.
- They can help insulate a person’s overall investment portfolio, as they sidestep investments in funds and companies that are vulnerable to the changing landscapes ahead of them.
- The combination of multiple themes blowing on a company’s business, compared to a lone one, allows well-positioned companies to capture incremental revenue and profits at an even faster rate.
How is thematic investing different than sector-based investing?
There are major challenges associated with grouping companies based on sector classification. Even S&P Dow Jones is realising the shortcoming to be had with that framework, and recently rolled out its largest revision to the Global Industry Classification Standard (GICS) since 1999. S&P Dow Jones now classifies thousands of companies across not 10 but 11 sectors.8
While there have been strides of late to update sector classifications, the reality is that these strides have built on already dated schema, and are nothing more than band-aids. At best, these changes are likely to become outdated yet again, and at worst, further complicate matters for investors.
For example, let’s take a look at how sector investing thinks about various companies found in its newest created sector – Communications Services. There are the usual suspects that one would think of when contemplating communications services – cable companies, such as Comcast Communications (CMCSA) and Charter Communications (CHTR), as well as mobile telephony companies like Verizon (VZ) and AT&T (T). But the sector classification also includes Walt Disney (DIS), which while it does compete with the content business at Comcast Corp. (CMCSA), doesn’t have a cable, mobile network or other communications business. And while AT&T has been historically a communications focused business, its acquisition of the WarnerMedia business has dramatically altered its business mix and product strategy. How does the Communications Sector view account for that? There are other head scratchers such as gaming companies Activision Blizzard (ATVI) and Take-Two (TTWO) which are consuming network data with linked, multi-player games, and so would they not be far more gaming and content companies, versus communication services companies?
And so on…the shortcomings expose the flaws with a system that groups companies based on pre-determined sectors. Inherent in this sector-based classification schema is the idea that companies don’t change their business models, but as we’ve witnessed over the years, that tends not to be the case.
Mobile infrastructure company, Nokia (NOK), originally started as a boot company, and now it is the second-largest holder of 5G contracts.9
Apple originally started as a personal computer company, but today its lion’s share of sales and profits come from the iPhone and its Services business, which did not exist 12 years ago.10 Amazon started off selling books, records, and similar items, but has continued to add to its business model and today is delivering all sorts of products and services that are a long way off from that original book-based business. Take for example Amazon Web Services, or its acquisition of online pharmacy PillPack, or the rollout of its Amazon Go stores that employ technology that could change the retail shopping experience entirely. Then there is Amazon’s Prime Video offering that stream TV shows, movies, original content and NFL games, it’s Prime music service, as well as its Whole Foods business. And then there is its Alexa/Echo digital assistant business that is moving beyond smart speakers to being incorporated into appliances, cars and home security devices.11 Is Amazon a Consumer Discretionary company like the Gap (GPS) or American Eagle (AEO)? Is it a Communications Services company like Walt Disney (DIS) and CBS (CBS)? Is it a Consumer Staples company like Kroger (KR) or Costco (COST)? Or is it an Information Technology company like Cloudera (CLDR) and IBM (IBM)?