How to pandemic-proof an investment portfolio to access future global trends

Do you have a bog-standard UK equity portfolio? Cherry Reynard suggests how to tweak it to suit the new reality and gain access to areas of structural growth.

As investors scan the financial market landscape in the wake of Covid-19, there are a number of inescapable truths. For example, it is clear that even with massive government stimulus, economic growth is likely to be hard to come by. Some trends have accelerated – e-commerce, online working, the energy transition – while the slow decline of a number of long-established industries has notably sped up.

Investors may be wondering whether their portfolios are positioned in such a way as to capture this new reality. Many will have based their portfolio positioning around a geographic allocation: a chunk of UK as a core holding perhaps, with some US, Europe and Asia around the edges. Unconsciously or otherwise, they will often have a bias to the largest companies, particularly if they have chosen to use passive funds for individual markets.

This could be more problematic in a post-Covid, low-growth era. Jerry Thomas, head of global equities at Sarasin & Partners, says: “If there is less growth, fewer companies can grow at a sufficiently high rate to offset cost inflation. Growth will be limited to fewer areas. At the same time, we are seeing large industries going through disruption – including financial services, oil and gas, and tobacco.”

For anyone with a bog-standard UK equity portfolio, this presents a problem. They are likely to be positioned in low-growth sectors, with little or no weighting to areas of structural growth – technology, for example. Does this give access to the growth themes of the future? Does it help avoid declining industries? Almost certainly not.

Simon Gibson, chief investment officer at Mattioli Woods, says: “The UK main market is hardly chock-a-block full of technology. To get access to artificial intelligence (AI), robotics, semiconductors or other exciting areas, you need a more cherry-picking approach than simply to sweep up the market and see what happens.”

Equally, there have long been problems with determining allocation based on geography. For many larger companies, their listing is an historical accident and bears little relationship to where they generate revenues. For example, the fortunes of BP or HSBC are not exclusively determined by the health of the UK economy, just as the French economy is not crucial for the success of Renault or Michelin. While there can be political risks – Gibson points out, for example, that technology and healthcare companies face a potential threat from this year’s US election – basing a portfolio allocation simply on where a company chooses to list seems like an anachronism.

Thematic approach

Themes need to be about more than just sectors. A thematic approach involves investing not in all technology companies or all renewable energy companies, but in areas that are reshaping society over the long term. In practice, the themes fall along similar lines across investment managers. Sarasin, for example, uses five main themes. It looks at digitalisation, automation, ageing, evolving consumption and climate change. These each then divide into sub-themes: thus ageing might include the role of healthcare, but also financial services, which should benefit from a greater need to save.

In creating a portfolio based on themes, investors could buy funds based on a series of individual themes: artificial intelligence, biotechnology, robotics, energy transition and infrastructure, for example. There are plenty of such funds available today – the Smith & Williamson Artificial Intelligence fund, the L&G ROBO Global Robotics and Automation ETF, the Schroder Global Transition fund and infrastructure investment trusts such as HICL or International Public Partnerships, for instance. Alternatively, investors can buy a global themed strategy that takes care of this for them, such as Sarasin Thematic Global Equity, Lazard Global Thematic Equity or the Pictet Global Megatrends selection.

Thomas points out that these trends can come with a regional bias anyway: “Europe is leading the way on climate change, renewable energy and low-carbon power, while Japan leads in miniaturisation and automation. The US leads in healthcare and digitisation, while China and India have created a range of new retail models that play to the ‘evolving consumption’ theme.” Either way, he says, it is the theme that leads rather than the geographic region, but any thematic portfolio is likely to come with a natural geographic diversification.

Gibson says: “In looking at whether a trend is likely to endure, it is really important to keep in mind whether this theme will be around in five to 10 years. This is not a tactical move, but investors should be looking for things that will stand the test of time.” The important element is that these themes should grow and develop over time.

But is it possible to construct an entire portfolio using this approach? Certainly, it is possible to achieve a blend of risks. Gibson says that some themes will be more cautious and others more adventurous. For example, artificial intelligence and biotechnology are at the higher-octane end, while infrastructure and energy transition may be more slow and steady options. Mattioli Woods will vary clients’ allocation depending on their appetite for risk.

However, Gibson believes there may be problems inherent in a fully thematic approach. There will be areas where investors have no exposure and this presents some risks, even if it avoids declining industries. There can also be spikes in demand for individual themes. At the moment, for example, demand for technology funds is high, with net inflows in 2020 already surpassing total levels for 2019. Polar Capital recently had to softclose its Global Technology fund on the back of significant inflows. This can create valuation problems.

Compelling stories

Some of these themes make for compelling stories: it it is not difficult to see the potential growth in artificial intelligence, for example. That said, there are relatively few ‘pure play’ AI stocks, so there can be a lot of money chasing relatively few companies. This can create volatility and ‘boom and bust’ dangers.

Thomas says: “It is easy to extrapolate what is happening today into the future, but were there to be a vaccine tomorrow, how much would go back to normal? It’s dangerous to assume that everything will be different.” Equally, he says, looking at themes can only be done in conjunction with other considerations: does the company have a good balance sheet? Is it well-run? Is it trading at a reasonable valuation?” He adds: “Companies with strong balance sheets can shape their businesses to reflect a new reality.”

The thematic approach is picking up steam, however. James Crossley, head of UK sales at Legal & General Investment Management, says that the group is seeing more interest in and understanding of thematic investing. Increasingly, they no longer have to explain the rationale behind a thematic approach. That said, he says that while capital is moving towards thematic funds, the number of investors who have switched to a fully thematic approach is relatively low.

Equally, for the time being it is difficult to adopt a thematic approach in other asset classes – such as property or fixed income. In general, the products aren’t available to support a thematic approach.

For the time being, a fully thematic portfolio is an ‘out there’ option. The building blocks are available, but there aren’t the portfolio construction tools or model portfolios to support it. Nevertheless, the virus has exposed the problems inherent in an approach based on market capitalisation and geographic allocation. Watch this space.

A new blueprint for portfolio construction

Balanced model portfolio

Source: Mattioli Woods model portfolios, as at 30 June 2020.