By tilting your portfolio toward these key themes, you may be able to generate higher returns and avoid industries poised to shrink.
Being able to identify the next big thing does not always help investors pick winning stocks. However, the right narrative can help them focus on long-term growth opportunities and also avoid industries that may be facing decline.
It is important for investors to stay diversified and my colleagues at Morgan Stanley spend a lot of time working on asset allocation models to optimize portfolios for different time horizons, goals, and risk tolerance levels. Within an allocation to equities one can seek to target specific themes without adding much risk.
That is where the work of my team comes in. The thematic team identified eight key shifts that are taking place in society, business and markets. These shifts are not tied to the economic cycle and do not always fit neatly into traditional sectors, which is why we usually recommend investors use a basket approach when adding themes to a portfolio.
Here are the eight key long-term themes for growth investors:
- Artificial intelligence (AI) and automation are likely to revolutionize the industrial landscape. This unfolding transformation is already leading to faster earnings growth potential at some of the large companies that have invested in developing these new technologies. This likely leads to new opportunities among start-up or smaller firms as these technologies mature.
- Leisure time is expanding, allowing people to spend more time on recreational activities. One reason for the growth: People are multitasking leisure activities like social media, gaming and watching TV. This creates potential for earnings gains in sectors like entertainment, travel and media.
- Demographics and low cost labor, long a driver of economic growth in emerging markets, may play a smaller role in an automated world. Countries that have high population growth in an industrial landscape dominated by technologies like AI and robotics could be at a disadvantage. Consider emphasizing countries making investments in the future competiveness of their workforces.
- Transportation could be very different in the future than it is today. Autonomous vehicles, electric cars, high-speed trains, drones and even space travel have the potential to revolutionize the movement of people and products. Understanding these shifts is critical to choosing investments tied to the transportation sector.
- Genetic research and related medical advances could change health care as we know it. The combination of biotechnology, nanotechnology and data analytics could usher in a new era of preventative and personalized medicine. Quality of life could improve and help drive economic growth.
- Learning to live and invest in an insecure world is difficult. Technology and globalization can drive economic growth, but can also have a destabilizing impact on society. Geopolitical risks are proliferating quickly. Investments in technology, people and support systems that can maintain security will be important.
- Improvements to energy, communications and transportation infrastructure are long overdue. New roads, rails, pipelines and networks are needed as millions of people around the world move from rural to urban areas. Strong global growth and low interest rates can help power the investments needed for the cities of tomorrow.
- Few companies can maintain pricing power these days. Technology has allowed for easy comparison shopping, increasingly efficient production and shifts in certain business models that can erode pricing power. However, companies that can maintain pricing power through technological barriers, unique products and brand recognition should be able to maintain an advantage.
A Word on Risk
There are additional risks—like concentrating too much in one sector or getting in at too high a price—that investors need to keep in mind when adding a thematic tilt to a portfolio.
My recommendation is to temper these risks by including both direct and indirect exposure to growth trends. Companies with indirect exposure (for example, a retailer that uses artificial intelligence applications for inventory management) may not have the same growth profile as market leaders, but a satellite portfolio using a broader set of firms may be less volatile.
Including direct and indirect investments in a theme can also manage the portfolio’s concentration in expensive stocks. Investors may not be able to eliminate these risks completely, but they can often improve the potential for long-term returns by adding a focus on key growth themes.
Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.
Growth investing does not guarantee a profit or eliminate risk. The stocks of these companies can have relatively high valuations. Because of these high valuations, an investment in a growth stock can be more risky than an investment in a company with more modest growth expectations. Value investing does not guarantee a profit or eliminate risk. Not all companies whose stocks are considered to be value stocks are able to turn their business around or successfully employ corrective strategies which would result in stock prices that do not rise as initially expected .
International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging and frontier markets, since these countries may have relatively unstable governments and less established markets and economies.
Alternative investments often are speculative and include a high degree of risk. Investors could lose all or a substantial amount of their investment. Alternative investments are suitable only for eligible, long-term investors who are willing to forgo liquidity and put capital at risk for an indefinite period of time. They may be highly illiquid and can engage in leverage and other speculative practices that may increase the volatility and risk of loss. Alternative Investments typically have higher fees than traditional investments. Investors should carefully review and consider potential risks before investing.
Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Technology stocks may be especially volatile.
Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.
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