Harnessing investment themes to identify long-term returns

Written By: Paul Markham Portfolio Manager, Equity Opportunities Team Newton Investment Management

Paul Markham of Newton Investment Management describes how a thematic approach to investment can help identify investment ideas capable of adapting to a changing economic landscape

The start of 2020 has been difficult for everyone as the global pandemic has taken hold, and there no doubt remain very challenging weeks and months ahead. We do hope, nonetheless, that this article will demonstrate how a thematic framework can help guide investors through the near-term noise to identify truly long-term structural growth stories.

Long-term themes as a framework
Themes provide a framework which can help the industry to think about the big changes affecting the investable universe and filter out any distractions. They do not tell us specifically what to buy or sell; as they concern long-term trends, they normally point to both winners and losers in different sectors. How themes can be applied to investment opportunities will transition over time, but below, we set out the thought processes around nine themes to demonstrate how a thematic approach can influence investment thinking.

Earth matters
Unprecedented population growth, technological developments and industrial advances have created stress across the planet’s climate, natural resources and wildlife. The resulting efforts to combat climate change have led to great innovation from “green enablers”, many of which we believe are well positioned in a world that is increasingly environmentally conscious.

Financialisation
We see the global economy’s ever-increasing levels of debt as the central reason why the global recovery (which began in 2009) has been so dissatisfying. We favour companies that can continue to grow in a slow-growth environment, with strong franchises that can generate good cash flows, while always being mindful of valuations.

China influence
China’s robust growth after the last financial crisis helped to pull the world economy out of recession, but now the Chinese economy itself has been on a borrowing binge and seems to require ever more credit to generate slowing levels of growth.

Consumer power
Increasing internet use has changed the consumer landscape, leading to increased choice and price transparency. Consumers can access and compare product information, as well as online reviews and influencer preferences, and as a result, consumer companies no longer control the narrative.

Smart revolution
A “smart revolution” theme can reflect how a range of technologies are making networks, systems, processes and products of all kinds increasingly responsive and intelligent. The revolution in connectivity is leading to profound changes to business models for many companies across the world and in many sectors. These technological advances are likely to drive increased productivity.

Internet
The world has made the transition from connecting places (landline phones), to connecting people (mobile phones), to connecting devices (satellite navigation). The rapid rise in the “internet of things” is transforming lifestyles and traditional business practices globally.

State intervention
Policymakers see sustainable growth as requiring more economic intervention, market manipulation and regulation. We believe this has led to increased volatility, inflated asset prices and poor capital allocation.

Population dynamics
Populations are shifting significantly – with unprecedented ageing in mature economies, and income growth driving changes in developing economies. This leads to differences in growth and fiscal burdens.

Healthy demand
Demand for health-care products and services is increasing as ageing populations fuel demand in developed economies, and expanding incomes and changing lifestyles create new markets in the emerging economies.

Themes in practice
Having provided a broad overview, we will now focus on one of these examples, and show how a thematic approach can help unearth investment ideas.

Smart revolution
One area that a “smart revolution” theme identifies is 3D printing. From the creation of engine components and medical equipment to recreating facsimile human organs, 3D printing holds the potential to revolutionise many scientific and industrial processes.

Imagine a world where a pair of perfectly fitting shoes could be tailor-made and printed while you shop and be made ready for collection within an hour, or one where healthy human organs could be printed quickly and efficiently for use in life-saving transplants.

First developed in the mid-1980s, 3D-printing processes allow specialist printers to make physical objects from a three-dimensional digital model, most commonly by printing layer upon layer of base materials such as alloy particles until a 3D object emerges. While 3D printing is, for now, mainly a specialist and niche manufacturing process, some feel it has huge economic and market potential.

It is estimated that the 3D-printing market will be worth over US$60 billion by 2030 in the oil and gas industry alone, with applications in areas as diverse as health care and biotechnology, food production, architecture, vintage car repair, avionics and jewellery manufacture all holding significant potential.¹

While some manufacturers have tried to market 3D-printed toys and other novelty products, our view is that these markets are largely unviable and unsustainable because alternative processes, such as injection moulding, are much cheaper. Instead, we believe the 3D-printing focus will increasingly fall on high-end engineering and processing applications.

From an industrial perspective, 3D printing is now much more focused on industrial precision applications like turbines and aviation engine manufacture. The processes 3D printing involves are very good at producing intricate parts such as aviation components which fit inside each other and must be precision-crafted. This efficiency of design can also mean lighter aircraft.

Facial-recognition technology is another area within a “smart revolution” theme that holds significant positive potential for other business sectors where there are a range of potential applications.

In the UK, what started as a closed-circuit television (CCTV) revolution in the 1990s is increasingly embracing facial-recognition technologies. In theory, these services – which are used to identify known individuals against an existing computer database – can help the police and intelligence services pinpoint known criminals, apprehend potential offenders and prevent crime. In practice, their use has proved more problematic.

While we believe there are legitimate ethical concerns around the application of facial recognition technology in particular, we are optimistic that more positive applications can be found for this technology and believe that it is an area of rich potential for software and electronic component manufacturers.

We have seen reports of potential abuses of facial recognition, especially in some more authoritarian emerging-market regimes, but there are also some far more benign applications for this technology; many airports are now widely using facial recognition to speed up passport checks, and some smartphone apps employ similar technology which allows users to unlock their phones via their facial image.

There are some ingenious domestic uses for facial recognition, such as video doorbells which can scan the image of callers and match them against visitors permitted access. At a retail consumer level we also see rich potential for this technology in creating more targeted advertising.

In the future, electronic advertising boards and pillars could include facial recognition technology, or gauge the age, broad socio-economic profile or even mood of people viewing them, and the display unit could change the adverts it shows accordingly; this type of device could become a common feature of shopping malls in the future.

We anticipate that the main beneficiaries of this technology will be micro-chip and software manufacturers, as well as data and internet service providers. As the technology improves, we are likely to see increasing everyday uses for it. Despite some ethical concerns from civil liberties groups, governments will also probably continue to use and develop these systems, ostensibly for security purposes. Indeed, we are already witnessing government use of such technology to gain control over the spread of the coronavirus pandemic.

Given the continuing and broadly-held concerns over terrorism and crime – and barring some serious backlash over the use of facial-recognition systems – it is also doubtful that any government would be willing to legislate in a way that would block its own ability to use it.

Conclusion
The pandemic continues to take a heavy social and economic toll globally, and we remain in the early stages of any recovery. Nevertheless, the macro backdrop will eventually change, and bring with it new challenges and opportunities for active global investors.

A thematic approach, backed up by a rigorous financial and ESG analysis can help investors adapt to an evolving landscape. In our view, using investment themes as a guiding framework to select securities and create portfolios can help screen out near-term noise to deliver better long-term returns for investors.

Your capital may be at risk. The value of investments and the income from them can fall as well as rise and investors may not get back the original amount invested.

Important information
This is a financial promotion. These opinions should not be construed as investment or any other advice and are subject to change. This article is for information purposes only. Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell investments in those countries or sectors.

Issued in the UK by Newton Investment Management Limited, The Bank of New York Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Registered in England No. 01371973. Newton Investment Management is authorised and regulated by the Financial Conduct Authority, 12 Endeavour Square, London, E20 1JN and is a subsidiary of The Bank of New York Mellon Corporation.

1. GlobalData. “3D Printing in Oil & Gas – Thematic Research”. September 2019.