A theme-driven approach – investing across multiple time horizons

Traders or investors?

Over time, the investment industry has become shorter and shorter term in its focus. True, the talk is still about investing for the longer term, but the words are now rarely matched by deeds. The media and the sell side happily feed this obsession. The focus is on the ‘next set of figures’ or the next event. Positions tend to be aligned with the current market narrative and short-term momentum. Investing is reactive rather than anticipatory. (Career) risk is still conveniently managed by not straying too far from conventional benchmarks. Risk systems are often imported from the world of trading and focus on volatility, which of course results in a pro-cyclical approach to risk management. On these kinds of timescales, and given the continued primacy of benchmarks – both actual or closet – valuation as a consideration is a very unreliable input into decisions. Sure, professional  investors feel obliged to constantly refer to it, but again, rhetoric and reality are often quite different things.

In the multi-asset team at  Ninety One, we believe that we can add  no value by employing trading strategies that rely on short-term ‘narratives’ and momentum. Indeed, we don’t believe this would serve the interest of our investors. We are investors, not traders. Instead, we focus on two time frames – the first being structural and longer term, the second being cyclical. We start by building a longer-term investment ‘road map’ using a top-down thematic macro approach. This focuses on the key areas of structural change, which represent the primary investment headwinds and tailwinds. We believe many investors do not sufficiently recognise these drivers. By understanding them deeply and building them into our investment process, we can gain a sustainable information advantage expressed through both our longer-term asset allocation decisions and more specific exposures within asset classes.

Why a thematic approach makes sense

In the past, thematic analysis has helped to identify important areas of superior performance. To cite just three examples: Japanese equities generated exceptional returns for investors in the 1970s as Japan emerged as one of the world’s largest economies; the onset of a disinflationary regime in the early 1980s has driven a 40-year rerating of bonds and equities, whereas the dawning of the internet age in the 1990s, has led to extraordinary value creation in the tech sector and beyond. Apart from identifying the important  long-term headwinds and tailwinds, a thematic approach helps in two other ways. Firstly, it allows us to cut through conventional industry classifications which are regional, sectoral or market capitalisation based – essential if, as we do, you believe in unconstrained investing. Secondly, it helps us to view the world from the perspective of the management of individual companies.

Our thematic research, which is co-ordinated by the Ninety One Investment Institute, comprises insights from internal cross-disciplinary teams and input from external knowledge networks. Currently, our research is focused on five overarching structural themes and the various sub-themes that flow from them. The key themes are demographics, debt, technological disruption, China’s rise and climate change.¹

Figure 1: Our Road to 2030 has identified structural thematic tailwinds and headwinds

Source: Ninety One, for illustrative purposes only.

Unpacking the key structural themes

China’s rise is a good  example of a major and evolving theme, which is set to remain a key force influencing the global economy and markets across the world. Through the 2000s, China’s fixed asset investment-led growth model created a material tailwind for commodity prices and producers – both companies and countries. But from 2010 to 2016, Chinese policymakers deliberately sought to rebalance the economy away from fixed asset investment, towards a consumption-led model. This resulted in a progressive slowdown in the rate of economic growth and the growth in demand for commodities. While this slowdown represented a material headwind for emerging markets and commodity producers in particular, the transition created a tailwind for luxury goods manufacturers and  Asian companies positioned to benefit from increasing discretionary spending and growing household leverage. Since 2016, we have held the view that supply-side structural reform throughout the Chinese economy would alleviate the negative headwinds for commodities and create conditions for a recovery. Rising wages have bolstered the growth in the Asian middle classes and have supported the Asian consumption theme. This example highlights how a major theme can evolve through time and why ongoing research is essential to understand changing investment implications.

Cyclical macro analysis

Studying the business cycle across major economies is an integral part of our risk management process and influences the amount of capital that we allocate to our longer-term thematic investment ideas. We aim to deploy a counter-cyclical approach based on two key beliefs: risk allocations should vary to reflect valuation and cyclical dynamics, and paradoxically, risk is highest when it appears lowest and vice versa.

We believe the appropriate level of exposure to market risk varies across the business cycle, with imbalances and risks growing progressively through the cycle and being ‘cleansed’ during recessions. Risk is therefore typically highest at the top of the business cycle and lowest in the early stages of recovery. Investors, however, tend to be most enthusiastic, often euphoric, at the top of a cycle, and conversely, are often unduly pessimistic in the trough of a recession.

Figure 3: We believe risk is highest when it appears to be lowest and vice versa

Source: Ninety One, for illustrative purposes only.

We closely analyse the business cycles of major economies, the United States, the eurozone and China in particular, focusing on growth, inflation and policy evolution. Importantly, this is not simply about monitoring data releases. Philosophically, we believe that policy has a reflexive influence over financial markets and future economic developments through multiple channels. Aggressive easing by a central bank can increase asset prices. In turn, this creates a wealth effect boosting business and consumer confidence, which improves economic fundamentals. This produces a virtuous cycle. The situation can also work in reverse, resulting in a vicious cycle of asset price deflation and de-risking. This is why assessing policy and financial liquidity dynamics is a very important part of our investment process. When we judge monetary and fiscal policy conditions to be sufficiently supportive, we respond by adding exposure to our riskier, higher growth long-term investment ideas, for example, cyclical companies. On the flip side, when we  judge policy to have become too tight, we decrease exposure to such ideas and increase exposure to more defensive assets, for example, developed market government bonds and the currencies of creditor nations. Hence, this analysis, combined with a continuous assessment of valuations, drives exposure to different asset classes and securities through time.

‘Fishing where the fish are’

Asset prices have moved up sharply across the board in response to extraordinary monetary and fiscal policy measures to offset the risk of deflation, unleashed by the global pandemic. As investors, we have to consider the implications of these challenging valuation levels and how we will be able to generate sufficient returns on our investments in future. If returns to conventional market beta are going to be a lot lower, we cannot rely on the simple overt or closet policies of ‘buy and hold’. At Ninety One, we believe in intelligent long-termism which requires a multivariate investment horizon. This allows us to maintain a strong focus on where the major areas of investment opportunity are over the longer term. We have to ‘fish where the fish are’ and dynamically deploy an appropriate level of exposure to those areas reflecting both an understanding of cyclical dynamics and valuation discipline.

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¹ Find out more about our Road to 2030 themes on our website at www.ninetyone.com/road-to-2030.