Recent research from S&P Dow Jones Indices found that the vast majority of large-cap, mid-cap, and small-cap investment funds underperformed their respective benchmarks over the last 10 years.
This isn’t surprising. 
After all, an investor that follows the herd can hardly expect to outperform the herd.
But what if there was a way to step away from the crowd, the market noise and short-term uncertainty? What if you could invest ahead of the curve, exploiting the forces driving society forward as they arise?
Enter thematic investing.
Profiting from a changing world
Thematic investing is many things, but at its core, it centres around structural change.
See, shifting economics, demographics, technologies, psychographics and regulation are continually shaping and re-shaping competitive landscapes in all parts of the global economy. The initial impact of these structural changes may be modest, but as they play out over long periods of time, they have the tendency to snowball into monolithic forces.
Let’s take a look at an example.
The current growth of the global population aged 65 and older is unprecedented. As “baby boomers” will continue to age over the next 10-years, we will see a massive change in demand for housing, healthcare and financial services across developed markets (including some emerging markets).
Approaching “themes” like this with foresight can be hugely profitable.
It is the companies that identify and position themselves for significant change at the earliest point possible that will be blessed with these remarkably strong tailwinds.
As these companies or “disruptors” ride the wave of the long-term trend, they capture incremental revenue and profits and ultimately become economic powerhouses. And as they do, their valuations increase by multiples, and their investors are rewarded with serious alpha.
Those businesses that lack innovation or are too sluggish to react, meanwhile, likely find themselves struggling to stay afloat.
The more tailwinds a well-positioned company can capture, the faster the rate at which their revenues and profits will grow. Research from McKinsey & Company points out that: “In [their] experience, the most attractive opportunities are found when multiple themes converge and reinforce one another”.
Investors who think thematically are able to identify the trends developing all around us and use deep sectoral expertise to find the companies best positioned to benefit as a result. The more undervalued and under-appreciated (and very often, under-indexed) these stocks are relative to the business opportunity ahead of them, the better.
All the while, this approach also insulates these investors’ portfolios by side-stepping laggard companies that are unable to embrace change and adapt their business models effectively.
A highly-nuanced approach
By using long-term perspectives to inform investment processes, thematic investing eliminates many of the limitations typically associated with sector-based investing.
As the name, sector, would suggest, investors build a portfolio of stocks based in one particular area of the economy like energy, communications or financials, and shoe-horning companies into a single, rigid classification like this gives rise to numerous issues, not least that it tends to result in the grouping of stocks with different focuses.
Look at S&P Dow Jones Indices’ most recent creation, the Communications Services sector, for example. At one end of the spectrum, you have the usual suspects like cable company Comcast and mobile phone provider Verizon. At the other, you have Walt Disney and gaming companies Activision and Take-Two. Can all these businesses truly be considered direct competitors?
Added to this, the sector model fails to account for the fact that companies often change their business models over time.
Amazon is, if you excuse the pun, a prime example. When it was founded back in 1994, the company sold books, records and other similar items. While it still does this in 2020, there is a whole lot more underpinning its $1.2trn market cap. Investors will be well aware that this e-commerce behemoth’s offering now includes (but is far from limited to) a video streaming service, a cloud computing platform (Amazon Web Services), the Whole Foods supermarket, digital assistants, smart speakers and even home security.
Today, one could easily argue the case for Amazon’s inclusion in a whole range of sectors, including consumer discretionary, consumer staples, communications services and information technology.
To this end, using a sector-focused lens is akin to investing with blinders on – it fails to identify and acknowledge why certain companies do well over time, while others do not.
In comparison, thematic investing captures these nuances. It does this by identifying the tailwinds and headwinds arising from changing landscapes, and which are most importantly driving revenues and profits for well-positioned companies. Backing the most thematically exposed of these companies can then deliver excellent long-term returns.
It is time for investors to look beyond the herd on Wall Street and back tomorrow’s leaders today.
Rahul Bhushan is co-founder of Rize ETF. The views expressed above are his own and should not be taken as investment advice.