Once considered niche, thematic equities have in recent years evolved into mainstream investments. Their ability to transform broad, long-term macro-economic, technological and environmental trends into investments has struck a chord with a growing circle of investors. Even so, questions remain over how to incorporate such stocks within portfolios that use traditional asset allocation frameworks. We propose three broad approaches where investors can incorporate thematic equities in their diversified portfolios.
Under this approach, a portfolio is split into two distinct parts. The ”core” is well diversified and typically contains traditional investments such as equities and bonds. It is built using a standard asset allocation framework and its goal is to capture the market return from various asset classes, or their “beta”. “Satellites”, in contrast, allocate capital to assets that fall outside the boundaries of the traditional asset allocation framework. They account for a smaller portion of the total portfolio, typically up to a maximum of quarter of total assets. Allocations to satellites are either made to express an investors’ structural, long-term view or to take advantage of opportunities that unfold over much shorter timeframes. Either way, the objective is either to access additional sources of alpha (a return that’s in excess – or independent of – the market) or to diversify risk.
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