Theme-based investing: A new way to align portfolios with future trends

Theme-based investing is a strategy that focuses on identifying and investing in themes or trends that are expected to shape the economy and the markets in the near future. These themes can range from technological innovation and demographic shifts to policy changes and environmental challenges. By investing in a basket of stocks that are aligned with a particular theme, investors can potentially capture higher returns and diversify their portfolios.

What are the benefits of theme-based investing?

Theme-based investing offers several advantages for investors who want to tap into the growth potential of emerging and evolving sectors. Some of the benefits are:

• Higher returns: Theme-based investing can help investors access sectors that are growing faster than the overall market and have strong long-term prospects. For example, electric vehicles, renewable energy, and digital payments are some of the themes that have outperformed the broader market in recent years.
• Portfolio diversification: Theme-based investing can help investors reduce their exposure to market risks and enhance their portfolio performance by investing in different themes that are driven by different factors. For example, investing in healthcare and education themes can provide a hedge against economic downturns, while investing in infrastructure and manufacturing themes can benefit from economic recovery and policy support.
• Alignment with personal values: Theme-based investing can also help investors align their portfolios with their personal values and preferences. For example, investing in environmental, social, and governance (ESG) themes can help investors support sustainable and responsible businesses, while investing in innovation and disruption themes can help investors support cutting-edge and transformative technologies.

How to identify and invest in themes?

Theme-based investing requires a systematic and data-driven approach to identify, capture, and evaluate themes. Some of the steps involved are:

• Identifying the catalysts: The first step is to identify the catalysts or drivers that are shaping the themes. These can be structural megatrends, such as technological innovation, demographic shifts, and climate change, or short-term trends, such as policy shifts, investor sentiment, and unforeseen events. For example, the Covid-19 pandemic has been a catalyst for themes such as online education, e-commerce, and biotechnology.
• Selecting the stocks: The next step is to select the stocks that are aligned with the themes and have the potential to benefit from them. This can be done by using various criteria, such as revenue exposure, growth prospects, competitive advantage, valuation, and quality. For example, selecting stocks that have a high percentage of revenue from electric vehicles, renewable energy, or digital payments can help investors capture the theme-based investing opportunity.
• Monitoring and rebalancing: The final step is to monitor and rebalance the portfolio periodically to reflect the changes in the themes and the stocks. This can be done by using data and analysis to track the performance, relevance, and attractiveness of the themes and the stocks. For example, adjusting the portfolio to include new themes that emerge or exclude themes that fade can help investors optimize their returns and reduce their risks.

Theme-based investing in India

Theme-based investing has gained popularity in India as well, with several platforms offering curated portfolios and exchange-traded funds (ETFs) based on various themes. Some of the popular themes in India are:

• Affordable housing: This theme is driven by the government’s policy push to provide housing for all by 2022, the low interest rates, the tax incentives, and the rising demand from the middle-income segment. Investing in this theme can involve selecting stocks of real estate developers, housing finance companies, and building material suppliers that cater to the affordable housing segment.
• Make in India: This theme is driven by the government’s initiative to boost domestic manufacturing and exports, the incentives for various sectors, and the geopolitical tensions with China. Investing in this theme can involve selecting stocks of companies that are engaged in manufacturing and exporting of goods and services, especially in sectors such as defence, electronics, pharmaceuticals, and textiles.
• Digital India: This theme is driven by the rapid digitization of the economy and the society, the growth of internet and smartphone penetration, the adoption of digital payments and platforms, and the emergence of new technologies such as artificial intelligence, cloud computing, and blockchain. Investing in this theme can involve selecting stocks of companies that are providing or enabling digital solutions and services, such as e-commerce, fintech, edtech, and data centres.

Theme-based investing is a new way to align portfolios with future trends and capture higher returns and diversification benefits. However, it also involves certain risks, such as theme selection, stock selection, valuation, and timing. Therefore, investors should do their own research, consult with financial advisors, and use effective risk management strategies before investing in themes.