Thematic investing is hard to miss when you’re scouting investment strategies and it seems like everyone is talking about it, but what is thematic investing?

Morningstar senior investment specialist Shani Jayamanne defines thematic investing as investors choosing to focus on a long-term or predicted trend as the basis to select investments for their portfolios as opposed to the merits of individual companies.

“For example, an extremely popular trend is lithium. Many investors see that lithium is a critical commodity used in the production of electric vehicles,” she says.

“Those that believe that the demand for electric vehicles will rise believe that this will naturally propel lithium mining companies as the demand for the commodity is intrinsically linked to the demand for electric vehicles,” she added.

Earlier this month, director of SMSF and investor behaviour at nabtrade, Gemma Dale, spoke at Morningstar’s individual investor conference addressing asset allocation in relation to thematic investing. In this article, we take a look at how thematic investing works according to Gemma Dale.

“People like a story they can understand”

In her session Dale explained that one of the key components to thematic investing is a story which investors can easily understand. She believes the tangible nature of seeing a product or seeing a need helps investors understand consumer demand.

She referred to the increase in investment in Australian milk producers like The a2 Milk Company in 2018 and 2019 to exemplify the power of a good story.

“It was absolutely in the newspapers, online, everywhere,” said Dale.

During that time, Chinese baby formula producers had experienced manufacturing issues causing the Chinese population to seek out high quality alternatives. The demand for reliable baby formula alternatives led to daigous buying multiple tins of baby formula to sell overseas, forcing stores to enforce a two tin per customer limit before shelves were stripped bare. This is what Dale believes made a great story that was easy to grasp.

“Walking into a pharmacy or walking into a supermarket and seeing empty shelves is a very tangible way of appreciating how strong the demand is for a particular product,” she said.

“There was enormous excitement about the potential demand for baby formula in China,” she added.

The a2 Milk Company reported in 2018 that its infant formula products made up 5.1% of infant nutrition in China. By 2019 the company had strengthened its position to a 6.4% share of the Chinese market. Meanwhile revenue from a2 Platinum infant formula jumped 84% year-on-year in 2018 and in 2019 increased an additional 46.9% to a total of $1.1 billion for the year.

The company’s share price skyrocketed in early 2020 to over $19 a share which represented a 1035% jump since trading at $1.70 in 2016.

 

“People like a story that is talked about”

Dale postulated that thematic investing happens when investors find a story that is constantly talked about like the energy transition.

The investing theme of an energy transition is one which has been brewing over the last few years, popularised by the need for more environmentally friendly energy sources.

The high price of fuel and the desire to find a more sustainable method of transport has led to the increased demand for electric vehicles. Clean energy automotive giant Tesla has been leading the electric vehicle trend.

The demand for electric vehicles has encouraged other car manufacturers to expand their range to gain market share, including BMW, Volkswagen, and Hyundai.

The one thing that investors have learnt from the growing demand for EVs is that car manufactures require lithium for rechargeable batteries. This led investors to increase investment into lithium mining companies such as Pilbara Minerals and Mineral Resources.

“Lithium is super-hot, absolutely super-hot,” Dale said.

“It makes buy-now pay-later look like a very small drop in the ocean compared to what is happening in the lithium sector right now,” added Dale.

Australian lithium mining company Pilbara Minerals has experienced a 43% jump in share price since the beginning of this year and a 123% increase year on year. The company announced total sale revenue of $1.2 billion, a 577% increase over the previous year in its 2022 annual results. Western Australian mining company Mineral Resources has also experienced considerable growth over the last year, with its stock price rising 31% since January and 93% year-on-year despite 2022 revenue slipping below last year.

 

“People tend to gravitate to one name”

The final factor in thematic investing according to Dale is the way in which investors gravitate towards one company that they know.

A perfect example of this was the success of buy-now pay-later company Afterpay.

Dale explains that Afterpay’s success stemmed from the fact that the company was the first to create a new market which did not previously exist and at its prime, operated in a new industry that had minimal regulation.

“Afterpay revolutionised an existing mechanism (laybuy) that was very clunky, unpleasant and did not work very well for the consumer,” said Dale.

She also explained that investors will not buy anything in a hot sector and instead attempt to pick a company that they believe will be the market leader.

“Afterpay was not the only runner in this race,” she said.

“Most people that we found in our database (nabtrade customers) would pick [the company] that they thought was the best story or the one that they thought had the greatest potential and Afterpay was clearly the hottest, and then just back [that company],” added Dale.

Prior to its acquisition by Block, Afterpay generated a total income of $503 million in fiscal 2020 with underlying sales rising 112% to $11.1 billion. The company reached a high of $158.5 per share in February 2021 after its initial public offering of $1 per share back in 2016.