Staying on Theme with Thematic Investing

    Date:

    Thematic investing and the strategies associated are big topics. There are many approaches and details to consider. In this episode, we look to answer foundational questions to help listeners understand the basics of the thematic investment market. Alex Gunz, Equity Fund Manager at Heptagon Capital joins Cassidy Clement to discuss.

    Summary – Cents of Security Podcasts Ep. 79

    The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

    Cassidy Clement:

    Welcome back to the Cents of Security Podcast. I’m Cassidy Clement, Senior Manager of SEO and Content at Interactive Brokers and today I’m your host for our podcast. Our guest is Alex Gunz, Equity Fund Manager at Heptagon Capital. Thematic investing and the strategies associated are big topics. There are many approaches and details to consider. In this episode, we look to answer foundational questions and help listeners understand the basics of thematic investment and its market. Welcome to the program, Alex.

    Alexander Gunz:

    Thanks so much for having me on your show, Cassidy.

    Cassidy Clement:

    Sure. So because this is your first episode, at least in a back and forth topical episode, why don’t you tell the listeners a little bit about your background in the industry?

    Alexander Gunz:

    That’s an absolute pleasure. I love talking about my background in the industry and in some ways the starting point is integral really for how we think about thematic investing today. So I started in financial services in ’97 and I was an Equity Research Analyst on the sales side here in London writing equity research on telecoms network operators and for context this was just at the beginning of the dot com boom. So it’s an incredibly exciting time to get started in the field and really in terms of a learning experience seeing the dot com boom all the way up to the peak in March 2000, all the way down to the trough in October 2002, and then out the other side was a very useful learning experience. And having done 13 years on the sales side, having been a top ranked equity research analyst, worked at big houses like Credit Suisse and J. P. Morgan. Like many people in our industry, I wanted to do something a little bit more niche, boutique, entrepreneurial, so I joined Heptagon Capital, a London based financial services boutique that manages and advises on about 14 billion of assets. And in January 16, I set up the Heptagon Future Trends Equity Fund, which I’m now responsible for managing.

    Cassidy Clement:

    So today when we’re going to talk about thematic investing, obviously it sounds like you have the right amount of experience and exposure in this area. And you are one of the authors on our Traders Insight where you’ve written about various things among the topics of thematic investing. So just to lay the foundation here, what exactly is thematic investing? Someone may hear it and think about the roots of the word, maybe it’s trend involved, maybe it’s a target or idea or focus. What exactly is thematic investing?

    Alexander Gunz:

    I think you’re going to find, Cassidy, that there are an awful lot of definitions out there, but from our point of view, the way we characterize thematic investing is essentially it is a subset of investing in equities on a global basis, and it is having a specific angle. So the angle in question is really, to our mind, trying to identify what we call long term future trends and then find the best businesses exposed to those. And when we are asked to define a future trend, we typically mean a trend that we think will grow in importance broadly regardless of what’s happening to global GDP and where governments or regulators, if they’re present, are typically tailwinds for that space rather than headwinds.

    One other nuance I think it’s worth sharing with all the listeners, Cassidy, would be the following. There are, as you might expect, many different approaches to thematic investing. Many of our peers or many funds that listeners may read about, hear about, will focus on single themes often very topical themes like AI at the moment, data, cybersecurity but the approach that we’ve taken at Heptagon Capital is quite explicitly to be a multi thematic fund. In other words, to invest in a whole range of themes and our argument is very similar to the idea of not wanting to put one’s metaphorical eggs all in one basket. By investing in multiple themes, one is diversifying risk and hopefully in a position to capitalize on multiple, often overlapping, important future trends.

    Cassidy Clement:

    So with all of the talk about trends obviously we’ve covered the idea of in other podcasts at least, there’s always pros and cons of different types of investment, especially when we talk about trends or seasonality or trying to find some type of pattern within your investment style. So with thematic investing, are there certain pros and cons that listeners may not be aware of or that come with this style of investment strategy?

    Alexander Gunz:

    I think that’s a great question and I guess the starting point in terms of answering it is the following: number one, what we regularly say in our dialogues with investors on this topic is that it’s easy in inverted commas to identify the theme. I think everyone just needs to open a newspaper or look on their phone screen and they’ll be aware of how AI is changing the world, there’s been a huge amount of commentary. If you were to take a different area about anti-obesity or weight loss drugs recently. So there’s a whole s swathe of themes out there. That’s the easy part, if you will. The much harder part, I think, is trying to identify businesses that benefit from those themes and it’s even harder if you’re an equity fund manager and you have certain constraints or guardrails, if you will, around the style of strategy that you are running. And where investors are worried about style drift or really drifting too far from the mandate. Really it’s very important to stay in one’s lane.

    So that’s the first challenge or consideration for any listeners that thematic investing, the easy parts, the themes, the hard part is the stocks. The second consideration is timing. You know, again, we all recognize that AI I sense is going to change the world, but how quickly is also open to debate. And to refer back to the early the earlier conversation we had, think about the the dot com boom and bust. It’s very easy to be right on a topic, Cisco’s optical fibers, for example, networked the world, they powered the internet but Cisco’s share price never really recovered from its dot com peak, and that sort of dynamic we sense could play out again elsewhere.

    Put it another way, it’s really important, I think, when you’re looking at thematic investing, to separate hype from reality. And there’ve been some themes for example plant based alternatives to meat healthcare IT, particularly telemedicine or virtual doctors where it’s been very evident to us that the theme has been really exciting at a certain moment in time, but the reality in terms of share price reaction from perceived beneficiaries has not always lived up to that.

    Cassidy Clement:

    You mentioned artificial intelligence quite a bit there. That may be a common theme that a lot of people are familiar with, but for our listeners who are just kind of getting into the area of thematic investing, what are some themes or maybe fund categories that they may be familiar with that can help them identify their previous exposure and go, ah, yes, I’ve actually been involved with a thematic theme or a thematic theme fund?

    Alexander Gunz:

    I guess the best way of answering that question is really to begin at the beginning and the way we try and map out, if you will, the thematic landscape is as follows. Think about it like this today, we’ve got 7 billion people roughly on the planet. If you believe most projections from the World Health Organization, United Nations, we peak at the end of this century, somewhere around 10 billion people on the planet. At the same time, I think almost every person around recognizes that we are dealing with shrinking available resource, whether it’s something as basic as water and food or the inputs, if you will, for energy to power electricity, to allow us to have a conversation even like this.

    So I think the starting point for us when we think about thematic investing and really from here we drill down to the relevant thematic areas is how do you allocate scarce resource in the face of a growing population? And we would argue that technology is, always has been and will continue to be a basic enabler for this process. So the very first theme piece we wrote in 2011 was all about the growth in data. And we said back then, and it’s proven totally true, that the amount of data produced will have zero value unless you secure, store, and analyze that data. And that creates a whole swathe of investment opportunities, everything from data centers to cloud hosting businesses, right through to AI, which you identified as being a critical topic today, and then also cyber as well.

    But then to come back to the whole resource allocation piece, think about it like this, there will be thematic opportunities within alternative energy, within healthcare, within food innovation, and then there will be further areas we haven’t touched on yet, such as financial inclusion. The digitization of cash would be one very obvious field to call out. Something like autonomous vehicles could also be of relevance. We think perhaps less so at present, but it will certainly be on some thematic investors radar screens. And really that gives, I think, a fairly broad sense of how the landscape is looking at present.

    Cassidy Clement:

    When there are people entering the thematic investment area or maybe they’re creating their own portfolio to follow a thematic investment strategy, what are some things that they should keep in mind? I mean, obviously risk is the most common thing to keep in mind with any financial strategy, but what are some things that maybe they should think about? I mean, in my research I was finding ever so often the phrase of, you know, themes and portfolios change over time and so should you. Portfolios shouldn’t always stay stagnant, and there should be some way that you can look at it from a long term strategy or short term strategy. So what are some things that you would tell listeners to keep in mind?

    Alexander Gunz:

    I think the most important thing, Cassidy, is this whole idea we touched on earlier on about staying grounded, separating hype from reality. So, yes, absolutely, themes can come and go and the number one reason why a business may exit from our portfolio is simply because the theme loses validity. In other words, the opportunity set is effectively eroded because of either competition or regulation or perhaps technological obsolescence. So those are the big picture things to identify. Certainly the themes we seek to invest in. We’re typically looking for a very long runway ahead. In other words, even take something like cloud computing that may be relatively old news in the world of technology, particularly given the advent of AI, only about 30 percent of all workloads exist in cloud based environments today. The vast majority remain on premise or take something like payment that I alluded to earlier on. Whilst it may be totally commonplace in London or New York to tap with your phone or with a piece of plastic, globally by volume, only about 25 percent of all payments occur digitally.

    So in other words, there’s a good long runway ahead there. So we would certainly look for longevity, if you will, of the theme runway ahead. We would want to check about barriers to entry, whether the validity, if you will, of the theme has been eroded by competition and regulation. And then typically what we’re looking for today at a micro bottom up level, when we’re considering potential businesses in which to invest, it’s really the strength of that company’s moat, in other words, it’s sustainable competitive advantages. How are they out innovating, creating those barriers to entry that will allow them to stay in the vanguard of that theme? And then clearly the final consideration that I think every investor obviously needs to be aware of is that one has to keep one’s sanity about valuation when we’re assessing businesses. We’ll obviously be looking at long term value for these businesses. So taking 10 years, at least of future cashflow, discounting that back to the present day and looking at the potential upside, but also we’ll clearly be looking at relative metrics as well. And I think the best way to think about thematic investing is really to look at growth, but growth at the right price.

    Cassidy Clement:

    With the growth element, you know, some example would be like AI, right? Nobody could have thought how quickly it was the hot topic, how quickly it became and stayed a hot topic. You talked about the dot com bubble, you can think of other things within the past hundred years but, you know, there’s different sectors and themes that can come and go, or that absolutely become these behemoths that are super crucial to our economy. So where exactly do you see the future of thematic investing? Maybe any new aspects that you can think of, whether it’s a fund theme, how users invest, etc.

    Alexander Gunz:

    I think that the key challenge within the broader world of investing is really staying relevant and staying differentiated. So, it really behoves every single fund manager, particularly those developing thematic strategies to really have that ability and to demonstrate that ability to continue to look around corners. To talk about AI once again, we first wrote about the investment case for AI in 2016, but clearly the topic did not take off really until late ’22, when ChatGPT went mainstream. Equally, something like quantum computing, we’ve been following that as a topic for a long time. We wrote most recently an update on that topic in 2022, and it’s really only now just beginning to get going. So those would be a few examples. And then I think it’s as Jeff Bezos of Amazon fame famously said today is day one. So you’re always effectively starting with a fresh page, looking at what themes could become important in the future. Certainly topics we at Heptagon Capital intend to be doing more work on in the coming a few months would be just to give two examples, one would be humanoid robots. I think we’re all very familiar with robots in factories helping to assemble cars, for example, but the idea of robots being able to perform more service like roles, particularly with the advent of AI the improvements in hardware and software, to us, that’s a very exciting opportunity.

    And then if you think about a different topic, different field, clearly we know that with data demands in general, not just AI specifically, the pressure on our electricity grids all around the developed world is only going to increase. And whilst I think many listeners will be familiar with the opportunities that already exist in wind and solar and the sort of growing resurgence or renaissance of nuclear, to our mind, something like geothermal energy could be very interesting as well. If you’d asked me a year ago, two years ago, I probably wouldn’t have mentioned either geothermal or a humanoid robot. So I think that just gives a small insight into how the thematic landscape is constantly evolving and how we have to adapt to it.

    Cassidy Clement:

    Yeah, it’s interesting because, as you mentioned, you know, you look at those major themes of the hot topics, if you will, which would be the AI, quantum computing, and then how that directly influences themes that involve power, utilities, renewable energy. It’s a very interesting snowball, especially if you’re looking to diversify into other types of themes. So all of these points come together, I think, really well to establish some type of a foundational understanding for thematic investing. Thanks so much for joining us today, Alex.

    Alexander Gunz:

    No, that’s an absolute pleasure. And I’d certainly say once again to all of your listeners, just stay fresh, stay curious, and to our mind, the best way of generating capital and indeed protecting capital, is to keep diversifying as well.

    Cassidy Clement:

    Yeah, absolutely. So as always, listeners can learn more about an array of financial topics for free at interactivebrokers.com/campus. Follow us on your favorite podcast network and feel free to leave us a rating or review. Thanks for listening, everyone.

    Disclosure: Interactive Brokers

    The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

    The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Interactive Brokers, its affiliates, or its employees.

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