Investing in Change: What Advisors Need to Know About Thematic Investing

By Nick Cherney

October 24, 2016 at 08:00 PM

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As an advisor, you know that there's a strong correlation between client engagement and business growth. When engagement is high, clients are far more likely to drive growth by making referrals. Being able to identify and offer the right portfolio strategies can help advisors not only deliver better client outcomes but also build more meaningful relationships.

Several new investment options are gaining traction because they enable advisors to connect with their clients at the point where their interests intersect with their investments. For investors, these strategies can help them achieve their financial goals while also addressing their concerns, passions and convictions. For advisors, these tools can open new opportunities to deepen their client engagement and grow their business.

Impact investment strategies offer this engagement by aiming to intentionally and positively impact the environment and society at large while also generating financial returns. With a market currently valued at $77 billion, according to a survey by the Global Impact Investing Network, impact investment products enable investors to identify opportunities and manage risks while assessing the environmental, social and governance (ESG) factors of a given fund or enterprise.

Passion investing, an allocation strategy aimed at high-net-worth investors, is a strategy that makes portfolio choices not simply for potential capital appreciation, but also for collectability and personal enjoyment. Art, jewelry, watches, rare coins and classic automobiles are among the asset categories that may offer diversification, asset protection and a return on investment, while also allowing people to invest in things they know well and care deeply about. These "investor-collectors" seek opportunities that may yield a decent return over the long term, and give them pleasure in the meantime.

Thematic investment funds are emerging as another tool for investors seeking to follow their passions and move beyond traditional style boxes. Building on the growing popularity of impact and interest-based investing, thematic investment strategies aim to provide exposure to companies playing a role in the demographic and consumer shifts that are changing the investment landscape, as well as the world we live in.

This is an approach that uses macroeconomic themes — like organics, renewable energy, new technologies, or health and wellness — to identify investment trends and opportunities. This broad strategy can potentially reduce portfolio risk, enhance returns and provide investment flexibility by diversifying portfolios away from the standard index-based investments. According to a recent survey by SourceMedia Research, close to 70% of advisors are either using these strategies or contemplating them. Furthermore, advisors who use these strategies report that 68% of their clients are either including or interested in including theme-based investments in their portfolios, the report found.

What Is Thematic Investing?

By their very nature, financial markets are focused on the present, on what is happening right now, but it's the long-term forces of change that will probably determine returns. Thematic investing goes beyond trendspotting to identify the socio-economic and political forces that permanently transform how we live and work. These catalysts of change can emerge from an invention or an idea, a reaction or a decision, but they create investable opportunities that are applicable over time and across global markets.

Henry Ford's Model-T assembly line, which permanently changed manufacturing worldwide, or the birth of the microprocessor in 1968, which launched the Information Age, are examples of transformative ideas or inventions that served as catalysts for sustainable, long-term growth. The energy crisis of the 1970s and the first Earth Day in 1970 brought nationwide attention to the U.S. dependency on foreign oil and to the challenges of air and water pollution. Reactions to these events led to the development of the alternative energy industry and the push for green products and technologies.

Transformative factors can emerge overnight or over decades. For example, the birth of over 76.4 million children between 1946 and 1964 gave rise to the baby boom generation that became a socio-economic force for change. The full sequencing of the human genome, completed in 2003, changed the diagnosis and treatment of disease virtually overnight, and has revolutionized modern medicine, and potentially, our longevity.

The forces of change that are transforming our lives now and into the future should create similar opportunities for investors over the next several decades. Among the themes with investable potential are the need for long-term care for the elderly, an increased focus on health and fitness, treatments for the global obesity epidemic and a growing demand for organic products. Strategies based on these themes may allow investors to target companies that will benefit from the socio-economic and demographic forces that are shaping the world.

An Organic Approach to the Market

The use of naturally derived products has been on the upswing in recent years, as consumers seek to protect themselves and their families from the toxins and pesticides used in growing and preserving much of our food. From food and drink to cosmetics and other personal care items, organic products are moving rapidly into mainstream American life. Companies that may profit from this increasing demand for organic products include those that service, produce, distribute, market or sell organic foods, beverages, cosmetics, supplements and green packaging.

As of 2014, 84% of American adults buy organic food as awareness grows about the health and environmental benefits of these products, according to Consumer Reports. The U.S. organic industry has seen a tenfold growth in demand, with sales increasing from $3.6 billion in 1997 to over $39 billion in 2014. And demand for organic food doesn't stop at home: 60% of U.S. consumers picked a restaurant because it offered organic or environmentally friendly choices on the menu, according to a report by the Organic Trade Association and National Restaurant Association.

Globally, the organic food market is projected to achieve a compounded annual growth rate of 16% through 2020. Grand View Research found that the U.S. exported over $550 million in organics in 2014, up from $412 million in 2011. This increasing demand is driving a shift in farming: Census data show that in 2015 there were roughly 19,500 certified organic farming operations, with more than 3,000 farms moving to organic products.

The global organic personal care industry, including natural cosmetics, hair care and skin care, is also seeing increased demand and is expected to reach almost $16 billion in revenue by 2020, according to Grand View. For skin care products, that represents a compounded annual growth rate of 9.8% from 2014 to 2020.

Long-Term Care Is a Life-Long Trend

Many of us have been touched in some way by someone in need of long-term care. This may include searching for an appropriate facility for an ailing parent or grandparent, or modifying a home to accommodate an aging family member. According to AARP, 22 million Americans care for their parents, older relatives or loved ones. With medical and pharmaceutical advancements continuing to extend our longevity (a man age 65 today can expect to live beyond 84; a woman can live beyond 86), the rapidly growing aging population is forecasted to create enormous needs and expectations for the long-term care industry.

In 2050, the population age 65 and over in the U.S. is projected to be 83.7 million, almost double its estimated population of 43.1 million in 2012, according to Census data. The Federal Interagency Forum on Aging-Related Statistics estimates that almost one in four 65-year-olds will live past age 90; one out of 10 will live past age 95; and 70% of people turning age 65 in the U.S. can expect to have some form of long-term care. A 2015 Urban Institute study estimates that between 2015 and 2055, the number of older Americans with severe long-term service and support needs will increase by 140%, reaching 15.1 million.

Unfortunately, the traditional source of caregiving — family members — may not be able to keep up with demand. In 2010, the caregiver support ratio was seven potential caregivers for every one person 80 and over. That ratio is expected to shrink to four-to-one by 2030 and three-to-one by 2050, the Urban Institute found. The size and scope of the U.S. long-term care market is already substantial, reaching more than $300 billion in 2015. Nursing care facilities are a $132 billion industry while retirement and assisted-living communities are $62 billion. Our increasing longevity will likely generate even stronger demand for long-term care. The senior living industry outpaced U.S. job growth by 3.7% between 2001 and 2014, and the industry will need an additional 1.2 million employees by 2025, according to Kalorama Information.

With long-term care poised to be an economic driver, attractive investment opportunities are possible in companies that are positioned to profit from providing a range of services and products for the aging population. This can include companies owning or operating senior living facilities, nursing services, specialty hospitals and senior housing, as well as biotech companies for age-related illnesses and companies that sell products and services to senior living facilities.

Investing in The Passion for Fitness

As a nation, we have become ever more passionate about fitness. Many of us rise before dawn to hit the treadmill, squeeze in a walk during lunch, or extend the workday with a spin class at the gym. In fact, 170 million Americans — 53% of us — are exercising at least three days per week, according to Gallup. As a result, the health and fitness market continues to grow as innovative technologies enhance fitness tools and facilities. Investors can participate in the potential benefits of this fast-moving trend with companies whose business is focused on fitness technology, equipment, apparel, nutrition, and sports and fitness facilities.

Fitness membership is driving the growth of new facilities and revenues. Participation continues to climb with an estimated 54 million Americans having at least one health club membership, up from 45.3 million in 2009 and 41.3 million in 2005. Since 2008, membership has grown by 18.6% and the total number of facility users increased 19.2%. The last few years have seen steady growth in the number of health club facilities, rising 6.4% to over 36,000, with revenues of $25.8 billion in 2015, according to the International Health, Racquet & Sportsclub Association.

Other growth engines include new technologies that are improving the performance of training and monitoring equipment, the food and drink used to fuel workouts, and the clothes we wear while exercising. For example, nearly 30% of U.S. households are using some kind of connected health device, with wearable technology and fitness trackers among the devices that have shown impressive growth, according to Parks Associates, a market research firm focused on emerging technologies. It found that fitness tracker revenue, which was at $2 billion in 2014, is predicted to grow to $5.4 billion by 2019.

The sports apparel and footwear industry has shown continued strength as health and fitness trends have taken hold around the globe. Revenue grew at a fast 42% pace over the past seven years to $270 billion in 2015. Expectations are that global uptake could push that figure higher by 30%, adding more than $83 billion in sales for a total of $353 billion by 2020, according to research from Morgan Stanley.

The Global Obesity Epidemic

Paradoxically, the surge of interest in fitness accompanies another long-term trend: the global epidemic of obesity. The numbers are startling. Over the last 40 years, the population of obese people has risen by more than 600%, with more than 640 million individuals worldwide now classified as obese, according to the World Health Organization. This alarming trend has rallied the medical community, governments worldwide and the commercial marketplace to confront and overcome the challenges and costs of obesity, according to a report by NCD Risk Factor Collaboration.

Obesity is a chronic and debilitating global condition. Worldwide, more than 10% of men and some 14% of women are classified as obese; those numbers are predicted to climb to 18% of men and 21% of women by 2025. In the U.S., 75% of men and 67% of women ages 25 and older are either overweight or obese, the report found. As obesity and overweight levels have risen, so too have the direct and indirect medical expenditures for treatment and prevention. A report by the National Center for Weight & Wellness at George Washington University and the McKinsey Global Institute found that globally, the obesity epidemic costs $2 trillion a year in health care costs and related lost productivity.

The sectors taking on the battle against obesity go beyond the health care arena. The global health and wellness market has been growing at 7.2%, with sales expected to reach $1 trillion by 2017. The weight loss market exhibits continued strength, in spite of a shift toward medical treatment, with the U.S. market valued at $64 billion in 2014. The low-calorie food market, pegged at $7.4 billion in 2013, is predicted to grow to $10.4 billion by 2019, according to Euromonitor International.

Global companies that could benefit by fighting the global obesity epidemic include biotechnology; pharmaceuticals; health care and medical device companies whose business is focused on obesity and obesity-related disease, including diabetes, high blood pressure, cholesterol, heart disease, stroke and sleep apnea; and companies focused on weight loss programs and supplements, and plus-sized apparel.

— Read The Growing Influence of Impact Investing on ThinkAdvisor.