This monthly report looks at the valuation and momentum indicators that drive our longer-term Investment (LTI) themes. We rank the themes by combining these quantitative indicators with qualitative screening to determine those that offer particularly compelling entry points for theme-oriented investors.
Our approach identifies “Diversity and equality,” “Frontier markets,” “Emerging market infrastructure,” “Family businesses,” and “Clean air and carbon reduction,” in that order, as the most compelling investment opportunities at this time. “Clean air and carbon reduction” replaces the “Obesity” theme, which this month drops out of the Top 5.
We recommend investors diversify by investing in multiple themes to mitigate drawdown risk. We also note that this does not change our conviction in the longer-term themes not listed in the report, which we continue to believe are well positioned to capitalize on secular trends over a longer time horizon. The report is meant to provide more context around which longer-term themes seemingly pair well with our current house view and whose quantitative factors appear attractive.
Our themes focus on more predictable global trends such as population growth, aging, and urbanization. These present numerous opportunities and could help companies increase revenue at a higher-than-GDP growth rate. Our assessment identifies the following themes as particularly timely:
• Diversity and equality: The focus on diversity and equality is gaining momentum, driven by societal changes, increasing pressure from regulators and stakeholders, and growing evidence of their benefits to business and the economy.
• Frontier markets: Demographics and urbanization provide frontier markets with higher medium-term growth potential relative to emerging markets and the world economy. Frontier markets constitute 5% of the world’s GDP, yet their equity market capitalization is only 0.4% of the global total.
• Emerging market infrastructure: Growth in infrastructure investments will outpace broader GDP growth in emerging markets over the next 5–10 years, in our view. Rising urban migration and the continued expansion of megacities in emerging markets are boosting demand for infrastructure investment.
• Family businesses: Family businesses tend to follow a long-term strategy and offer an alignment of interests between the company managers and the key shareholders. As a result, they potentially offer
good growth and risk-return characteristics given their conservatism and focus on quality and innovation.
• Clean air and carbon reduction: Clean air is a basic human need. The transition to cleaner and more efficient energy sources is being helped by strong global political support to mitigate the threat of climate change, boost technological progress, and gradually lower costs.
Addition to the top 5…
Clean air and carbon reduction
Investment case: Political support, technological innovation, and falling product prices all argue for what we view as a major investment opportunity in the clean air and carbon reduction theme. Three technologies are driving growth and reshaping industries: 1) wind and solar photovoltaic (PV) energy (with strong new installations); 2) battery-powered electric vehicles (we expect growth to be exponential rather than linear from 2020 onward); and 3) low-carbon and disruptive energy technologies used in buildings (industry and energy networks will lower energy demand directly at source). As energy consumption and CO2 emissions continue to rise in tandem with GDP growth, finding sustainable ways to reduce emissions is becoming increasingly urgent. Our theme should benefit from stricter, more environmentally oriented standards and a sharper focus on addressing climate change and improving air quality. We believe this should drive higher sales, and we anticipate 5–10% annual earnings growth in the theme over the next two decades.
Why invest now: “Clean air and carbon reduction” enters the LTI Top 5 ranking this month due to a positive qualitative assessment, as well as a favorable valuation and quality score in the quantitative assessment. The United States recently passed the Inflation Reduction Act of 2022, which includes several spending initiatives that should help to accelerate the energy transition. Further, several important agreements were reached last year in the 26th Conference of the Parties (COP26) of the UN Framework Convention on Climate Change. The EU has already presented its plans for reducing carbon emissions and becoming carbon-neutral by 2050, China and other Asian nations are aiming to reach carbon neutrality by 2050–60, and 141 countries have committed to halting and reversing deforestation. The Russian invasion of Ukraine accelerated the aim of the European governments to become more energy independent, which will require greater investment in energy security, including renewable energy. In early March, the EU launched the REPowerEU energy plan, which aims to reach independence from Russian gas well before 2030.
Content is a product of the Chief Investment Office (CIO).
See the full report – Our favorite longer-term themes, 7 September, 2022.