Thematic Investing: Forcasting Tomorrow's Forcast
By Daniel Paduano, David Wilson and Sherrell Aston
July 13, 2011
AN INVESTING COMPASS
Thematic investing is all about anticipating and capitalizing on secular change. Major demographic, societal, technological and political developments around the world create abundant investment opportunities. The key is to position your portfolio to take advantage of the changing landscape before many of the changes actually happen. This requires substantial research and preparation to separate shorter-term fads from true paradigmatic shifts that have visibility of at least five to seven years. During tough periods in the market, our themes serve as a compass, or a lighthouse on the horizon, guiding our investments by providing a focus for our decisions.
French scientist Louis Pasteur is quoted as saying, “In the field of research chance favors the well prepared mind.” At the Paduano Group, we prepare our minds by studying a range of foreign affairs, scientific, historical and social theory books and journals, as well as industry trade publications and a host of other periodicals. We rely less on CNBC and The Wall Street Journal and more on the big-picture thinking you’ll find in the Atlantic monthly or Foreign Affairs. We also interact regularly with field experts, thought leaders and policymakers to further assess and select the global and truly secular themes that have merit. Quite importantly, we then apply our investment discipline to choose companies and stocks that we believe are best-positioned to take advantage of the theme.
Below we would like to share with you three of our most compelling investment themes today.
THE RISING VALUE OF WATER
In essence, the price of water has to go up in order to afford access for people. Although water covers nearly three-fourths of the surface of the earth, less than one percent of it is fresh and useable for agriculture, industry and human consumption. In the United States and throughout the developed world, we may not fully appreciate the value of clean water for drinking and bathing, but around the worldâ€”and especially in developing economiesâ€”availability of potable water is a major issue affecting economics and health. In fact, according to a 2006 United Nations study, half of the world’s hospital beds, at any given time, are occupied by patients suffering from waterrelated diseases.
Especially worthy of note is that places with the largest or fastest-growing populations, like China, India and the Middle East, have the biggest problems with water scarcity. The problem is worsening, with reports documenting the shrinking Himalayan glaciers that feed rivers flowing into these countries, as well as all of southeast and central Asia. Even in the U.S., high-growth areas like Las Vegas and Southern California wrestle with water availability, while older cities need replacements for crumbling water infrastructure. The journal Nature carried a study at the end of last year showing that 80% of the world’s population is exposed to high threat levels when it comes to water security.
We believe that these water problems and the accompanying investment opportunities revolve around five primary areas: pricing, recycling, cleaning, desalinizing and transporting. Together, research estimates peg the total addressable market for water solutions at $450 billion worldwide and we believe we’re still in the early days of global awareness.
MARKET SIZE OF WATER SUBSECTORS
ENERGY: CONSERVATION, RENEWABLES AND ALTERNATIVES
Supplies of traditional sources of energy are declining or getting more expensive and difficult to extract and distribute. Additionally, much of the world’s supply of fossil fuels is located in geopolitically challenging regions. Combine these constraints on supply with the burgeoning demand from rapidly growing countries across the developing world and the imperative for conservationâ€”as well as developing new sourcesâ€”becomes quite clear.
Some solutions that have already begun to emerge include hybrid and electric vehicles to reduce the demand for fossil fuels and the development of the “smart grid” and smart buildings to manage electricity generation and use more efficiently. Renewable and alternative sources of energy like wind and solar power are also rising in importance, along with infrastructure improvements to help make natural gas more transportable and useful.
The conservation theme also extends to less obvious areas, like materials sciences and manufacturing. Greater use of lightweight titanium and carbon fiber is leading to more fuel-efficient engines, planes and automobiles. Greater adoption of LED lighting, which uses far less electricity to produce the same illumination as traditional incandescent or fluorescent light bulbs, is another extension of this theme.
To get a sense of the global nature of the conservation and renewable theme, take a look at India and China. India currently generates approximately 11% of its electricity needs from renewable sources, up from 3% in 2003. Through 2017, India plans to spend $33.8 billion on renewable-based power generation capacity, putting it on track to become the fastest-growing renewable energy market. China is now the world’s largest producer of alternative energy with investments focused heavily in solar.
SMART SYSTEMS: MAKING DATA INTELLIGENT
Our interest in Smart Systems evolved from our “personalization of media” theme of five years ago, which focused on the growing global demand for voice, video and data anytime, anywhere and on any device. With more than 5 billion phones in a world of 6.7 billion people and wired and wireless broadband networks offering ever higher speeds and availability, ubiquitous access is just around the corner.
Perpetually connected, we are now inundated with digital bits â€” data, e-mails, texts, instant messages, documents, pictures, videos â€” all flowing toward us at an almost paralyzing pace. McKinsey & Co. recently reported that Facebook users share 30 billion pieces of content every month. The same study highlights that in 2010 alone, all new data stored worldwide, across enterprises and consumers, was the equivalent of filling up the Library of Congress more than 60,000 times.
This data deluge is creating huge demand for systems that can harness and extract value from it. It is our belief that in the information age, organizations with the most robust, reliable, and secure data will be the winners. We are therefore focused on those businesses that analyze, manage and protect large amounts of data. The economic imperative of making data intelligent is compelling. McKinsey estimates that the U.S. health care system could potentially save $300 billion by using data more efficiently and that the public sector in Europe could save $250 billion through smarter data management.
STICKING WITH A THEME
These are just three of the investment themes that we’ve identified and acted upon. We invest thematically because it places the powerful winds of secular change at our back and it helps us differentiate between what is sustainable and what’s ephemeral. When your investments are part of a larger construct, it’s easier to stay focused on the big picture. We believe this is a necessary precondition for successful investing.
(c) Neuberger Berman