Themes

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I was talking to someone yesterday and the question of thematic investing came up.

Themes have come up many times on the blog as the idea plays a big role in the way I construct portfolios. Themes would appear to be a top down concept but perhaps a bottom up investor could make a case the other way.

The reason I think it fits in with top down is that most themes start from 30,000 feet. One I stumbled onto in 2004 was that anything good for oil will be good for Norway. If you think about it that is a pretty vague starting point, no less true for being vague but vague nonetheless. I would also add that it is a very simple idea as well. No one has ever been confused when I have said that.

The way a theme gets implemented may or may not be a little more complicated. I started out in 2004 with Statoil which has generally been a good hold although the last year or so it has had a little less impact on the portfolio. I have disclosed quite a few times having bought Norwegian two year sovereign debt last spring for some accounts which might have been a little more complicated and not the right type of position for every account.

As I say it might have been more complicated even then it really wasn't. Norway is a surplus country (the surpluses are still growing), GDP has been very healthy, it was pretty clear there would be plenty of rate hikes to come and if nothing else I was, and still am, convinced Norway is at a different point in its economic cycle which at a minimum creates some diversification.

This all seems like just a series of fairly obvious observations as opposed to any sort of black box study.

The forest for the trees element of the process makes the job of construction and then ongoing management much easier to do.

Infrastructure is another obvious theme. Well it is and it isn't. The money is going to be spent, it will be billions and billions, all over the world over a long period of time.

The various stocks will at times outperform and at other times lag. The chart shows Abertis (ABE.MC) the Spanish toll road company which has done better YTD than SPX and has predictably been less volatile. Foster Wheeler (FWLT) has predictably lagged SPX YTD and been more volatile so obviously for a bear market the toll road idea is better.

Not so fast my friend, I mined the data, Transurban (TCL.AX)the Australian toll road company has been about even with SPX YTD but has been more volatile while Flour Corp (FLR) has beaten SPX YTD. This hopefully makes the point that the theme might be obvious but how it is accessed may not be.

Flour's outperformance notwithstanding no matter when someone buys it they are adding volatility. The toll roads are usually less volatile but not always. Sticking with the example of how to add infrastructure (and let me be clear I don't own any of the names being tossed around in this post) attention then needs to be given to the volatility (and other) characteristics of the overall mix of the entire portfolio and how the name you are considering adding affects the rest of the portfolio.

Keeping it simple and assuming Abertis lowers vol and FWLT increases vol, based on where you think we are in the stock market cycle (talking generically not right here right now) do you want to increase or decrease the vol? If you want to decrease it and you choose Abertis you then need to decide how you feel about Spain and how Spain fits in--there are some economic parallels to the US and while Spain was doing very well a while back the risk there, like most places, has ratcheted up a bit.

Or you can just buy an ETF.

Hopefully this illustrates that the theme can be simple but accessing it may or may not be simple.