Analysts at Bank of America Merrill Lynch (BofA ML) argue that thematic investment can reap rewards for investors and allow them to ignore short-term noise by focusing on themes that will influence markets over much longer time frames.
The annualised return from global thematic investing, as measured by the progress of biotech, waste and cyber security stocks, is 32 per cent over the past three years versus a 15 per cent return from global equities, a note by the analysts says.
“Theme investing should continue to outperform in the brave, new, post-QE world. Position for lower expected returns from financial markets by concentrating portfolios in assets related to our long-term themes,” they wrote.
“Cyclical and secular trends continue to transform our world at a fast and meaningful pace. Such trends include the following: 50 per cent of all government bonds in the world currently yield 1 per cent or less; in the next 20 years one in three UK jobs will be replaced by computers or robots; there are an estimated 122,000 cyber-attacks per week; 47 countries are officially classified as water stressed; and over half of Europe’s population will be aged 50 or older within 10 years.”
With this is mind, BofA ML suggests seven themes that long-term investors might want to get exposure to.
Financial repression
The assets of the world’s central banks now totals $22.6trn, including foreign exchange reserves, which is larger than the combined GDP of the US and Japan. Meanwhile, some 83 per cent of the world’s equity market cap is supported by zero interest rate policies and half of all government bonds in the world currently yield 1 per cent or less.
BofA ML said: “The current level of global interest rates, both real and nominal, is depression-like, with only the 1930s a comparable period. Currently, 1.4 billion people are experiencing negative real interest rates. Low rates mean low returns and enhance the appeal of theme investing.”
Looking at investment implications, the analyst says investors should position themselves for the spike in volatility that is likely to come in 2015 as the “denouement of financial repression” approaches, which will take the form of either rising interest rates or debt monetisation.
Robotics
The bank tips the rise of robotics technology as a major theme of the years ahead, noting that a growing number of jobs are likely to be replaced by computers or robots. In 2013, for example, Nike hired 106,000 fewer contract workers because of automation.
“In 2014 and 2015, robot installations are estimated to increase by 12 per cent per year, with the trend to automation continuing to be driven by corporate focus on cost competitiveness, outsourcing of engineering functions, increasing quality requirements and rising wage inflation across emerging markets,” the analysts said.
They add that companies include industrial automation and robots, robotic surgery, control systems and equipment and industrial PCs/smart planet spaces should be beneficiaries, offering the US’ General Electric and Taiwan’s Advantech as stock picks.
Cybersecurity
Around 122,000 cyber attacks are carried out each week, according to BofA ML, with major attacks being made on eBay, Home Depot and JP Morgan this year. The average cost of a successful attack on a US firm is $12.7m and cyber crime is thought to cost the global economy around $500bn a year.
“With cybersecurity attacks and critical infrastructure breakdowns now recognised as one of the top five global risks today, we expect companies to increase investment significantly,” the paper said.
“In our view, companies that should benefit from cybersecurity include content security, network security, data protection, hardware based on software blades, identification and analysing machine generated big data.”
The Internet of Things
The number of connected devices is expected to reach 7.2 billion in 2015 – quite the increase from the 500 million in 2003. By 2020 this is tipped to pass the 50 billion mark, meaning more than six connected devices for each person on the planet.
BofA ML says the Internet of Things (IoT), which includes sensors and smart nodes being incorporated into various devices to enhance connectivity between previously unlinked pieces of equipment, will reach its “tipping point” in 2015.
“Seventy-five per cent of companies are either actively exploring or using IoT, and 96 per cent expect their business to be using IoT in some respect in three years. We estimate the IoT market size for software will be $36bn by 2017,” the analysts said.
“This will not be a replacement market, but rather will generate incremental revenue opportunities in areas such as big data, analytics, data/app integration, the sales cloud, marketing cloud, as well as end-to-end vertical solution providers.”
Solar
Solar energy is seen as a growth industry, thanks to factors such as water scarcity (around 90 per cent of global power generation is water-intensive) and sharp falls in the equipment, customer acquisition, permitting and financing costs of the solar industry.
BofA ML said: “Penetration remains low in this addressable market that continues to grow, particularly in the US. By 2016, our alternative energy team estimates that the total addressable market for residential and commercial market could exceed $25bn of electricity sales in the US alone.”
The analysts say businesses involved in the financing, installing and servicing solar power arrays, solar project developers, and wind and solar power generators are positioned to benefit from this trend, highlighting the US’ Sun Edison, Germany’s Nordex and China’s China Longyuan.
Water
“A perfect storm is threatening,” the analysts said. “By 2030, global food demand is set to increase by 50 per cent, energy demand by 50 per cent and water demand by 40 per cent. The threat from this nexus is increasingly evident, particularly regarding water, with geo-political tensions over water and energy coincide with a sharp rise in drought and water stress.”
“Drought affected 100 per cent of California this year and Brazil suffered its worst drought in 80 years. By 2030, it is estimated that half the people on the planet will be living in conditions of water stress.”
The water market could be worth more than $1trn by 2020, the research suggests, pointing out that firms active in the China water treatment, ‘more crop per drop’ actors, water meters and medical waste treatment areas could benefit. UK stocks highlighted included Melrose, which owns a business that works on measuring and improving the flow of water, and plumbing products supplier Wolseley.
Longevity
An ageing population is a universal trend, the bank notes, with the number of older people forecast to grow from 841 million in 2013 to more than 20 billion by 2050. There’s an investment case for the pharma and healthcare, senior living, insurers, drug stores, and death care sectors as a result.
“Average life expectancy has risen by 20 years since 1980, and by the end of this century there will be 8 million centenarians,” the analysts explain. “We believe that all aspects of society and the economy need to be viewed through the lens of this demographic and societal transformation.”
BofA ML’s stock picks for the longevity theme include a number of UK companies. These include Legal & General and Old Mutual in the financial sector; Thomas Cook from the leisure sector; and Smith & Nephew from the medical device sector.
