This is an introduction to a series of articles to be published in the following weeks and months that will investigate niche sectors and future-orientated themes as opportunities for investors – and the vehicles that allow access to them.
Trying to predict the future is for some the very essence of investing.
Many thorough-minded investors will say it’s only a part, as they focus more on company fundamentals and economic realities in an effort to pick out the best stocks.
But others, for better or worse, invest on the basis of educated guesses about where the world and the economy is going. About which sectors and geographies will prosper and grow over the coming years.
Investing is intrinsically a future-looking game. And as the pace of technological and societal change gets ever more drastic, there’s lots of future-looking to be done.
Some of us are better than others at spotting trends that are here to stay: So is it best to leave it to the professional investors?
The problem is, to paraphrase a famous saying, the future is another country – they do things differently there. Another canard dictates that you shouldn’t invest in what you don’t understand.
Certainly, before leaping into specialist sectors it’s best to make sure you have a balanced portfoilio already that suits your risk outlook. Even for adventurous investors, speculative themes should not comprise the core of their portfolio.
Jason Hollands, a director of wealth manager Tilney, says you may already have exposure to a particular theme without the need to invest in a niche fund.
‘For example, if you own a US tracker fund in your Isa or pension, over 27 per cent of this will be in technology stocks, so don’t feel you are missing out by known owning a technology-badged fund,’ he adds.
Exposure to specialist themes can ‘add spice to things’ but it tends to be risky and is best suited to adventurous investors.
‘Areas like robotics, artificial intelligence, renewable energy and biotechnology are exciting, but they are niche parts of the market and the greater the exposure you have to a particular – and narrow – theme, the more risk you are taking on,’ he says.
‘It is also the case that the investment industry is notoriously faddish. This can mean that investors get lured in by the hype or dazzled by past returns. You need to be confident that a particular theme is going to be relevant for the longer-term.’
He adds, however, that ‘sustainable investing is definitely here to stay’.
Adrian Lowcock, at Willis Owen, agrees that the landscape can rapidly change.
‘Investing in niche fields should be treated cautiously as it can be risky and it is not always clear where the leader will come from or which theme will be successful,’ he says. ‘For example clean energy has its fans, but it could be that an oil major with all their resources makes the best progress.’
James Norton at index funds provider Vanguard says that rather than trying to second guess which sectors are going to outperform, ‘you should instead focus on holding the broadest and most diversified portfolio possible’.
‘The best chance of investment success comes via a portfolio that is diversified, balanced, and held for the long-term at a low cost.’
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Some DIY investors however, may decide that if you invest in everything, you end up with too many losers. If you think exciting growth sectors are just too good an opportunity to leave to the generalists, the decision then becomes how to include that bit of extra spice in the Isa.
Technological and innovative change is transforming not just the end-investment, but the medium or instrument we use to invest. The consideration of how to invest now takes up as much cogitation as what to invest in.
While identifying growth areas and trends that are due to accelerate is not a sound basis to start ploughing cash into the shares of an individual firm, it is for many investors enough to back the sector. That’s where funds and investment trusts come in.
But now we also have a bewildering array of vehicles and instruments to add to the mix, the most popular being passive funds like trackers and ETFs.
The choice of investment method you choose may depend on the sector that you are targeting. Can a tracker fund or ETF do what you want, or do you need a fund manager stock picking their way through investments that may not even feature on the stock market?
Jason Hollands says that specialist sectors or themes, ‘naturally play to an active fund management approach, particularly in more nascent growth areas where companies tend to be at the smaller and younger end of the spectrum and are sometimes not included in market indices at all’.
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‘These companies are less well researched and can also be less liquid and therefore spotting the winners and avoiding the landmines is key, which is the job of an active manager,’ he adds.
Those with faith in active managers and who are happy to pay the fees, will want a specialist fund that can do more than just ride a sectoral or geographical wave. They trust that it will add returns on top of their benchmark by identifying the better firms in the sector.
This has worked spectacularly for those who put money at any point before about May this year into the current poster boy for investment trusts, Scottish Mortgage.
There is also the hope that, as times change, the manager will adapt their thinking and restructure the vehicle to reflect them, so it won’t tank even if the mood turns against it.
Tim Cockerill, investment director at Rowan Dartington says it’s worth bearing in mind that not all companies in a sector will be successful: ‘Often the fund manager will have experience of the sector, perhaps having worked in it, and so there is a level of understanding about the opportunity and risk that’s just not found in an ETF. ‘
But some investors just want a ‘pure play’ on a sector. Those with less faith in managers and less willingness to part with 1 per cent or more from their annual returns now have at their disposal a huge range of tracker funds and ETFs.
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They can mirror every bit of the zeitgeist, every sector and sub-sector, from battery technology to cyber-security to ageing populations, by following an ever greater and more esoteric range of global indices.
Being more agile and easily established these instruments tend get there first, offering exposure to themes before funds and investment trusts can.
Ben Seager-Scott at Tilney says that thematic investing using ETFs is considerably more viable now that a few years ago: ‘primarily because the index providers have become considerably more sophisticated in how these indices work’.
‘[They] are constructed with a much deeper view, analysing financial statements to identify firms that having key driving themes, and sometimes using expert advisory panels to determine whether a company fits the theme (which starts to blur the line between active and passive),’ he adds.
‘The result is the launch of products that are much purer plays on particular themes, and tend to capture a basket of companies rather than trying to pick winners within a theme (as active funds do) – arguably using an index approach is a better representation of a theme.’
Two other advantages of taking the passive approach are that they are usually considerably cheaper than active funds, and they can be much more targeted, allowing investors to be very specific in the themes they are looking to benefit from.
Active funds tend to have a broader remit. With nascent sectors there just aren’t enough companies for the big investment house to get involved.
Sam Slator says that if an active fund or investment trust doesn’t exist, ‘perhaps ask yourself why it doesn’t exist – are there simply not enough investment opportunities in that area to make it worthwhile?’
Ben Seager-Scott admits the possible pitfalls of small investors’ intellectual curiosity getting the better of them: ‘This can be a potential risk if investors get drawn into a so-called “narrative fallacy” that can forget the base investment case and investors should always be aware of risks such as the potential constraints on diversification, and the challenges of winner-takes-all markets.’
Christopher Gannatti, Head of Research at ETF provider WisdomTree, says that when building thematic ETFs, ‘there is no substitute to expert knowledge and judgement of these highly specific spaces’.
‘Many providers turn to rules-based algorithms to build their indices by scanning through thousands of patent filings and pages of market data. But partnership with subject matter experts results in a more differentiated strategy than those using algorithm-based stock selection.’
Even if the technicalities of the end-investment are beyond you (and lets face it, for most investors in the case of most funds this is true), you should know what index it tracks, and how the passive fund is structured.
Jason Hollands observes that when investing in index funds, ‘you will be exposed to the very largest stocks and where a theme is currently in fashion’.
‘This can result in you being heavily exposed to those companies whose valuations have already ballooned into very expensive territory,’ he adds.
To pick through these issues I’m embarking on a series of articles about growth sectors, future technologies and niche themes that readers might want to back – and how they can do so, even if it is just a small part of their portfolio.
The first and most obvious area of interest – subject as it is to fresh policy drives by both the UK and US administrations – is green (or clean, or renewable) energy and indusrial and technology sub-sectors with an environmental focus.
The universe of investment products in this area has grown rapidly and it will be too much to cover in single piece: so I’ll be writing one on open-ended funds (to be published tomorrow), the second on investment trusts and the last on passives – tracker funds and ETFs.