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Capturing megatrends via thematic investing

September 2021
Dwijen Gandhi

Senior Director, Equity Index Research and Development

The advantage of a transparent, rules-based approach

Thematic investing is booming. As investors watch ‘megatrends’ flourish - rapid urbanization, electric cars, sustainability - they have increased allocations to funds that allow them to gain exposure to these growing macroeconomic patterns.

This approach to investing is not new. A focus on technology, media and telecom (“TMT”) investing first took hold in the late 1990s and early 2000s. Later, the advancement of the ETF industry saw the first wave of thematic products come to market. Today, structural changes such as low interest rates, aging populations, and climate change have led investors to seek returns from thematic strategies. The COVID-19 pandemic has also accelerated certain megatrends: remote work, biotech innovation and e-commerce.

Assets under management for thematic funds grew 77% in 2020 and now comprise around €572bn ($US668 bn) of assets worldwide, according to research commissioned by AXA Investment Managers. Across the globe, ETF and mutual fund managers are striving to launch products to meet this demand, and in turn, are looking to index providers to design indices that represent various megatrends. There are regional differences in the preferred investment vehicle for thematic strategies. For example, Japan is the largest market for thematic mutual funds after the U.S. and Europe. Yet Japan lags Taiwan, Hong Kong and China in the thematic ETF space due to regulatory and market structure reasons according to the Financial Times.

Thematic investing differs from sector or industry investing. While the latter may include companies with a single classification - such as the ICE Biotechnology Index - thematic indices can include companies spanning multiple sectors and industries.

Depending on the interpretation of a megatrend, two indices that aim to represent the same theme can result in very different index compositions and outcomes. For issuers seeking to establish thematic funds, selecting the right index methodology based on high quality data is therefore important for the success of a strategy.

Thematic indices: advantages of a rules-based approach

  • Greater transparency for investors on why companies are included in an index
  • Companies must meet transparent, pre-defined criteria and not be subject to discretionary decisions
  • Index constituents and changes are more predictable for end users
  • Utilizing high quality, quantitative data to compile thematic indices allows for greater customization capabilities

At ICE, our index methodologies are designed with the aim of providing a targeted representation of relevant megatrends. Indices that are transparent and rules-based, such as requiring a certain percentage of company revenues to be sourced from a specific sub-industry or product, provide more predictability to users on the composition of an index and any changes.

One example is the ICE FactSet Global Autonomous Electric Vehicles Index. The index is constructed based on company revenue and supply chain relationships data, and targets material aspects of the industry from car manufacturers and automotive technologies to battery material suppliers. The index was recently licensed by Cathay Securities Investment Trust for the largest foreign equities ETF in Taiwan.

Another example is the NYSE FactSet U.S. Infrastructure Index, which aims to track the performance of companies involved in the U.S. infrastructure value chain, from asset owners and operators to their upstream enablers. The index - licensed to BlackRock for a U.S. listed ETF - uses a methodology that relies on company and geographic revenue data to represent the range companies that could benefit, including industrial, materials, and utilities firms.

Other thematic indices that ICE has developed include a genomics and immuno biopharma index which includes many of the biotech companies fighting COVID-19. In addition, a series of semiconductor company indices highlight the importance of the semiconductor supply chain and semiconductor chips on almost every single global technology - from mobile phones to autonomous driving. ICE also has advanced customization capabilities and can work with clients to help define a megatrend, then compile a methodology and backtest to represent it in index form.

As demand for thematic investing continues, fund managers will be challenged to design products that best capture a given megatrend. Here, the importance of well-designed indices will come to the fore. At ICE we’re confident in the advantages of a transparent, rules-based approach to help investors capture the opportunity in thematic strategies.