Investing in the major socio-economic, environmental and technological themes of our times is becoming more accessible than ever, but how do investors sift through the fads to find the megatrends?

I recently spoke to James Whelan, Investment Manager for VFS Group on his views of the major trends in 2021 and how to identify them for your portfolio.

Thematic investing and megatrends

Investing in megatrends is a type of thematic investing. It involves considering long-term macro trends, such as robotics and automation, and using various screens and information sources to identify the companies or assets which support this trend through infrastructure or services.

Thematic investing is sometimes confused with sector investing. While it’s easy to see how this can happen, thematic investing is more tailored and can span several sectors or even asset classes. To illustrate this, consider the growth trend for technology. While one way to incorporate this might be simply including a sector investment in information technology, a thematic investment might also consider companies outside of this sector classification which also stand to benefit by providing services associated with technology, such as Amazon or Netflix.

Thematic investing has increased in popularity over time due to greater access and grew in popularity in 2020 as investors sought investments tapping into the COVID-era, with exchange-traded funds (ETFs) a particular beneficiary of this interest. There are some indications this growth will continue and 2021 will be the year of the thematic investment.

Mr Whelan says, “there has never been a better time, or a time that has been more accessible for regular retail clients, regular mums and dads at home, or people just on the computer at home, to gain access to those ETFs, and those themes and those areas that they want. Whereas before, you would have had to try and pick out the stocks. There's now ready-made packages for you that you can look at and actually start to pick apart to do the homework for you.”

Megatrend or fad?

The abundance of often conflicting media describing trends or opportunities can make it difficult to identify whether something is a fad or a long-term growth pattern.

Mr Whelan identifies a megatrend using two particular indicators: demographic shifts and government support.

“If there is a big demographic shift that's going on, for example, Southeast Asia, the growth in China and Southeast Asia of people moving into the middle class, that's something that's been talked about for ages. What do they eat? What changes do they make? What do they buy? What do they like to do on holiday? All of those things, that's a huge demographic shift… Government stuff. Once the government starts spending money on something, if you're in front of that wave, that's a bottomless pit of money,” he says.

Another example of a demographic shift accompanied by government activity is increasing environmental awareness and movement towards clean energy and electric vehicles. Alongside this, government activity on this front has recently ramped up, with local examples being the Victorian Government’s plans to build a new battery storage facility or the NSW Government’s Renewable Energy Pipeline. Investors have a range of options for accessing this, from direct company shares in battery companies to funds such as ETFS Battery Tech & Lithium ETF (ASX: ACDC) which collates across the supply chain.

By contrast, he views fads as activities with less substance, more noise behind them.

“If everybody's talking about it on Twitter and everybody wants a piece of it…Then I think it's a bit of a fad, and I'll have a bit of a look into it. When it’s not a fad is when there’s actually regulation,” Mr Whelan says.

He notes that fads can become trends down the track but views government regulation as the key turning point for that. For example, medicinal marijuana stocks spiked a few years ago without accompanying supportive legislation in Canada or any other country and he is wary of investing in this area without the government backing.

Trends in 2021

After an unusual and challenging 2020, this year has started with hope as a result of vaccine rollouts and signs of economic recovery. Mr Whelan sees a few trends for the next year.

Firstly, small capitalisation companies have shown significant growth in recent times and he views this as backed by economic activity.

Mr Whelan says, “after the Biden Government's $1.9 trillion spending budget goes through, we're going to see the US consumer is going to have $2 trillion worth of excess capacity to spend on things, that is absolutely great for small caps and that's going to be very, very bullish for that area.”

Economic recovery also brings the prospect of inflation, an area Mr Whelan selects as his second theme.

The final theme is more technical and is based on a predicted shortage of a very specific item – semi-conductors.

“There is a semiconductor shortage in the world at the moment. Huawei was hoarding semiconductors before they all got cut off. Electric vehicles now need how many semiconductors? 40% of the cost of a modern car is put on computers. Computers need semiconductors. You've had car manufacturers have to shut down production because they literally cannot get semiconductors just in time because they've been running on just-in-time. When there's a shortage, prices go up. When prices go up, you find a way to meet it,” says Mr Whelan.

Rather than investing in individual companies, Mr Whelan has found using ETFs useful for this particular trend as it is difficult to predict which companies will best rise to the circumstances. He cites the ETFS Morningstar Global Technology ETF (ASX Code: TECH) as offering a suitable exposure to semiconductors, along with other key technology components.

When to move on from the trend

Just as it’s important to know whether something is a trend worthy of investment, it can also be important to know when to no longer invest. This comes down to a simple rule for all forms of investment in a portfolio, not just thematic investments.

Mr Whelan says, “if the underlying reason as to why you bought it has changed, then you don’t need to be in it anymore. That’s the simple enough reason to be in and out of anything.”

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