Portfolio construction around themes not sectors

Rachel Alembakis

By

08/10/2018

Quoting Bob Dylan’s classic line, “The times, they are a-changing”, Curt Custard, chief investment officer of Newton Investment Management, spoke of his support for analysing portfolios based on narratives and themes that respond to changing risk-and-return assumptions as a means of asset allocation.

Speaking to the audience of the Investment Magazine Absolute Returns Conference in Sydney, Custard noted that structural breaks at the macroeconomic and corporate level were increasing, making it harder to apply traditional asset allocation models to portfolio construction.

Business models are also blurring, making it harder to classify securities along traditional measures. To illustrate this, Custard cited Amazon, which started out as a bookseller and is now a trillion-dollar multi-sector conglomerate.

At Newton, Custard manages along “dynamic business model” lines.

“Dynamic business models mean you have to think about things in a different way, you have to approach analysis differently,” he said. “Most asset managers are organised along GICS sectors, along asset classes. I would argue that it’s increasingly the least relevant way to look at the world. You need to look at the world and what is driving the global economy and changes affecting the global economy, and allocate your resources to be able to maximise your exposure and insight into these areas.

“Much like you can slice and dice a portfolio across asset class or across factors, you can also do it across narratives and themes.”

Newton analyses themes across metrics bolstered by behavioural finance theories, Custard said.

“Breadth, identifying a theme across connections, across how it impacts the sector and the broader economy, the magnitude of that theme, the influence that it has on our daily lives, and the duration of this theme – in each of these areas, the human brain is ill-suited to try to estimate its impact, and therefore there is a lot less short-termism and headline-ism, if you will, in the expression of these themes.”

Custard then explained how Newton’s portfolios are organised by pulling out four of its themes – earth matters, our wellness, ageing, and technology affecting the environment. Newton bundles securities on the basis of their relationship to the themes. The resulting portfolios are geared towards equities and market exposure and are more biased to small- and mid-sized equities than the reference MSCI World index. Newton believes there is a statistically significant alpha outperformance to be gained from organising around that thematic approach.

“As we continue to research this and continue to show themes that have worked and haven’t worked, we think this is a very robust way of looking at the world,” he said. “Unfortunately, if this were some kind of panacea, [we could all] invest in themes and go home, but themes don’t always make money.

“I think we’d all agree that the internet is a thing, but if you bought the dot-coms in ’99, you lost a lot of money. In no way will this ever substitute for the benefit of taking a more considered human analysis at the end stage of the process.”

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