Equity investing with a thematic lens: Three game changers for 2023

We believe now is a time of great transition for asset allocators. With investment regime change challenging the status quo across global markets, asset classes, and sectors, should allocators be questioning many of the assumptions that have underpinned portfolio decision-making for the past two decades? We think so — at least from an equity standpoint. In our view, thematic investing can help allocators navigate this evolving landscape.

A contextual framework for thematic equity investing

In today’s era of heightened market volatility and rampant investor “short-termism,” having conviction in compelling, long-term structural trends could prove to be a defining edge, in terms of both risk management and return generation. Macro uncertainty has triggered wild sentiment swings, resulting in market rotations along factor, sector, and country lines, with seemingly little consideration of company-by-company idiosyncrasies. In many cases, industry leaders are being discounted at the same rate as their less-innovative peers. Meanwhile, competitive moats are expanding as the cost of capital rises. Forward-looking management teams are doubling down on the multiyear trends that are impacting their business, while other firms are overly fixated on near-term profit margin protection. The market's underappreciation of these nuances is being exaggerated by compromised liquidity across global equities, amplifying the severity of both up and down market moves. 

Against this backdrop, rigorous investment research, direct engagement with companies, and agile active management are likely to be even more critical drivers of long-term outperformance. Equally important, in our judgment, is to have a distinctive investment process built on robust cross-discipline collaboration. Leveraging insights from our global industry analysts and equity research teams, we strive for early identification of market inflections and price disconnects across sectors, including technology, financials, industrials, health care, energy, and consumer products. 

To a large degree, “megatrends” undergird our investment convictions — longer-term trends and themes that we believe are going to structurally alter global market dynamics, asset pricing, and ingredients for 21st-century corporate success. Many high-quality, secular growth companies appear poised to benefit from one or more of these megatrends. Here are three areas where we see opportunities in companies that may be relatively well positioned to weather the risk of an economic slowdown over the next 12 months and beyond.

Megatrend: Climate change and ESG integration

There is virtually no sector of the global economy that is immune from climate-related disruption. And as climate change intensifies across the globe, efforts to adapt to and mitigate the myriad consequences will only accelerate. While the so-called “energy transition” is beginning to dominate public climate discourse and also the flow of investors’ climate dollars, the path to a world of “net-zero” carbon emissions will require game-changing economic and corporate transformation of the sort not seen since the industrial revolution. Given the diversity and complexity of the challenge, markets are likely to miscalculate both the risks and the opportunities, potentially leading to exploitable asset price disconnects. Environmental, social, and governance (ESG) integration strategies can be a powerful way for equity investors to do just that.

Investment play: Silicon carbide in the electronification of autos
ESG investing and integration can of course take multiple forms, even within a particular sector. In global technology, we are most excited about the growing need for better, more reliable power management and, specifically, the evolution in power management semiconductors — an essential component in electric vehicles (EVs). An uptick in EV sales is becoming more evident worldwide, although the rate of adoption varies sharply by region and country. For example, many European nations have dramatically outpaced their global counterparts, including the US, which does not even crack the top-15 list (Figure 1).

Materials science advancements over the past decade have propelled the development of a new generation of silicon carbide-based semiconductors that can enable continued efficiency gains for EV makers. As these gains take hold in the years ahead, we anticipate further cost reductions in the manufacture of EV systems, likely improving affordability for car buyers and thereby helping to fuel the trend of increased EV adoption. Working off a dual theme of decarbonization and digitization, we expect this to be a big upcoming inflection point in global consumer demand for these more environmentally friendly vehicles.

Megatrend: The revolution in enterprise data

While global digitization has been a durable megatrend for roughly the past two decades, we believe it still has much further to go. The volume of enterprise data produced is growing by around 40% annually, and the convergence of key enabling technologies — the cloud and robotics, artificial intelligence (AI) and machine learning (ML), the Internet of Things, fifth-generation (5G) technology — is likely to be a potent catalyst for how this thematic story continues to unfold in the period ahead. Enterprises are in a strategic “arms race” of sorts to aggregate data and integrate the software necessary to reap efficiencies from that data. How well companies execute on that will determine the winners and losers across sectors for the next decade or more. 

Investment play: Software as a service/New cloud-based databases
With the 2021 – 2022 correction in many next-generation software-as-a-service (SaaS) stocks, we identified several new investment ideas. One area we find attractive, especially amid the unrelenting march of ever-more data creation around the world, is the continued growth of data and the need to manage it more effectively. Many providers of next-generation database management tools and services stand to benefit mightily from this trend, much of which comes down to the “cloud” — servers that are accessed over the internet, along with the software and databases that run on those servers.

Public-cloud expenditures as a percentage of total IT spending have risen significantly across every sector as enterprises seek third-party solutions for organizing and extracting insights from data. In fact, worldwide public-cloud services end-user spending could reach nearly US$600 billion by the end of 2023 (Figure 2). The proliferation of public and private clouds has spawned a need to transfer the data and databases associated with traditional workloads to a similar architecture. With fully cloud-architected database vendors emerging, we see a multi-decade market share opportunity for these new players. This is one of our highest-conviction investment ideas going into 2023.

Megatrend: The demographics of an aging population

In recent decades, an array of medical breakthroughs and refinements, together with generally healthier lifestyles across much of the world, have boosted average human life expectancies into the 70s and even 80s in some countries. This has fundamentally reshaped the global demographics picture: With people living longer than ever before, the share of the world population aged 65 years or older increased from 6% in 1990 to 9% in 2019. That proportion is projected to climb further to 16% by 2050, such that approximately one in six individuals may be senior citizens at midcentury. Moreover, while the entire globe will age rapidly over the next three decades, the developed world is doing so at a much faster pace than emerging markets (Figure 3).

Investment play: Genome sequencing technology to optimize health care
The potential implications of this seismic demographic shift are profound and far-reaching across sectors and industries, no more so than in the health care space. For example, how much might global demand for health care technology and services spike by 2050? By 2080? The answer to this and other questions will play a pivotal role in long-term return outcomes within different health care subsectors. For investors, deep research will be central to recognizing early on and capitalizing on the various manifestations of changing global demographics. 

One pocket of investable opportunity within modern health care, which overlaps with the tech theme of digitization, lies in the onset of the next generation of genome sequencing equipment. (Broadly speaking, “genome sequencing” involves establishing the entire genetic makeup of an organism or cell type.) There is now stepped-up focus on reducing the cost to sequence the genome, allowing for major new modalities in preventing, diagnosing, and treating many chronic illnesses, such as heart disease. We believe approaching platform releases by existing leaders in sequencing technology, in addition to advancements by next-generation companies, should help drive strong future performance from the life sciences subsector of health care.