If you follow the herd, how do you expect to outperform the herd?

That is the question we ask when we look at data published by the S&P Dow Jones that shows that over the last decade, the vast majority of investment fund managers have underperformed their respective benchmarks. They, in effect, lagged behind the S&P 500, Dow Jones and Russell 2000, because they were following the crowd.

We try to take a more comprehensive approach, combining as many tools as possible that will help optimize our returns/ minimize losses. We rely on a combination of strategies, and in the series of free educational content that we are offering, we will discuss a strategy that is among the very first steps to starting an investment portfolio. We call this thematic investing, which we're going to explain here. As we go forward, we will look to inject some of the concepts discussed below in our writings and other commentary. To be clear, we are not abandoning anything that has gone before, but rather adding tools and a different perspective to augment and better serve subscribers as we hunt for outsized returns over the longer-term.

Let's dig in.

Thematic Investing in a Nutshell

Let's start out by sharing our definition of thematic investing. First, it does not group companies based on predetermined sectors. Thematic investing instead focuses on structural changes that come from shifting global economics, demographics, technology, and psychographics and -- from time to time -- regulatory mandates. These structural changes alter consumer and company behavior and therefore spending in one form or another. That sea change in spending gives rise to thematic tailwinds that power the businesses of companies that have identified and positioned themselves to ride those tailwinds, either organically or through buying or combining with other companies. Companies that capture incremental revenue, profits and cash flow stemming from these structural changes tend to be rewarded with expanding valuation multiples over time. Thematic investing tries to figure out what causes "alpha" -- or the ability of a company to outperform.

Further, because thematic investing isn't based on sectors, it isn't trapped in antiquated thinking. Rather than a vertical, siloed approach, thematic investing is a horizontally focused strategy that cuts across sectors and geographies to identify companies that are best positioned to capitalize on long-term catalysts. We explain more on that later.

This evolving and forward-looking investment approach helps us position the portfolio for changes in development of new technologies, new business models, and shifting demographics that reshape the needs and preferences of the world's population. Apple (AAPL) gets categorized as a consumer electronics stock, but that doesn't do justice because much of Apple's revenue comes from software and services subscription. Companies like Skyworks (SWKS) , Advanced Micro Devices (AMD) have vibrant outlooks thanks to a rising demand for digital infrastructure and connectivity. 

Why Thematic?

Thematic investing allows investors to focus on the structural changes or themes that will play out over the longer-term, shaping and altering competitive landscapes, but also to look past short-term market or sector noise and uncertainties.

Themes have advantages to investors, such as offering recognizable signals that are digestible and relatable to investors -- and help them to make investing decisions based on things they know and can observe.

They can help insulate a person's overall investment portfolio, as they sidestep investments in and companies that are vulnerable to the changing landscapes ahead of them. Not all companies recognize the evolving landscape in front of them. Case in point: Nokia at one point had over 40% market share in the mobile phone industry, but it totally missed the adoption of smartphones.

How Thematic Investing Differs From Sector-Based Investing

There are major challenges associated with grouping companies based on sector classification. Even S&P Dow Jones is realizing the shortcomings of that framework, and recently rolled out its largest revision to the Global Industry Classification Standard (GICS) since 1999. S&P Dow Jones now classifies thousands of companies across 11 sectors. While there have been strides of late to update sector classifications, the reality is that these efforts have built on already-dated models and are nothing more than Band-Aids. At best, these changes are likely to become outdated yet again, and at worst, they will further complicate matters for investors.

For example, let's take a look at how sector investing thinks about various companies found in its newest sector, "Communications Services." There are the usual suspects -- cable companies, such as Comcast Communications (CMCSA) and Charter Communications (CHTR) , as well as mobile telephone companies like Verizon (VZ)  and AT&T (T) .

But the sector classification also includes Walt Disney (DIS - a portfolio holding) , which while it does compete with the content business at Comcast Corp., doesn't have a cable, mobile network or other communications business. And while AT&T has been historically a communications-focused business, its acquisition of the WarnerMedia business has dramatically altered its business and product strategy. How does the Communications Sector label account for that? There are other head-scratchers, such as gaming companies Activision Blizzard (ATVI)  and Take-Two (TTWO) , which are consuming network data with linked, multi-player games, and so would they not be considered more gaming and content companies than communication services companies?

These shortcomings expose the flaws with a system that groups companies based on pre-determined sectors. Inherent in this sector-based classification method is the idea that companies don't change their business models, but as we've witnessed over the years, that tends not to be the case.

Mobile infrastructure company, Nokia (NOK) , for example, originally formed in the late 1800s as a paper mill operation and later made boots and other rubber goods, but now it is the second-largest holder of 5G contracts.

Apple (AAPL) originally started as a personal computer company, but today most of its sales and profits come from the iPhone and its services business, which did not exist 12 years ago.

Amazon (AMZN) started off selling books and records, but has continued to add to its business model and today is delivering all sorts of products and services that are a long way off from that original business: Amazon Web Services, its foray in to the pharmacy business, its rollout of Amazon Go stores, its Prime Video offering and Prime music services and its Whole Foods business. 

Is Amazon a Consumer Discretionary company like The Gap (GPS) or American Eagle Outfitters (AEO) ? Is it a Communications Services company like Walt Disney (DIS)  and ViacomCBS (VIAC)? Is it a Consumer Staples company like Walmart (WMT) or Costco (COST) ? Or is it an Information Technology company like Microsoft (MSFT) and IBM (IBM) ?

We could continue but it is rather apparent that trying to shoehorn companies into predetermined lists of sectors isn't always easy, and increasingly this process fails to properly reflect the true nature of a company's business. Viewing the market through a sector lens fails to capture the real-world tailwinds and catalysts that are driving structural changes inside industries. These nuances are far better captured in thematic investing, which focuses on those changing landscapes and the tailwinds as well as headwinds that arise and are driving not just sales but operating profit inside of companies.

We came to this point of view after decades in equity research analyzing countries, sectors, and companies on Wall Street. We realized that sector-focused thinking leads to investing with blinders on and the traditional approach failed to identify and understand the underpinnings of why certain companies do well over the long-term, while others don't.

The Difference Between a Fad, Trend and Thematic Investing

Generally speaking, investing on a trend or fad is a strategy that aims to capitalize on rising sales and profits from a short-lived phenomenon. We see these all the time in the apparel industry where new styles achieve short-lived popularity, but then fade away. That "fade" is indeed what coined the term "fad." While trend investing can be profitable for an investor, the challenge is in correctly timing one's entry and exit to maximize profits. Stay in too long, and an investor risks seeing his or her profits shrink, if not evaporate as the trend fades away.

Because thematic investing focuses on evolving structural changes, the duration of a theme is not measured in weeks or months, but over years. Initially, a structural change may have a modest impact, but over time as those changes unpack themselves, the impact becomes increasingly pronounced. Evolving technology and changing psychographics as well as demographics also have a role to play in the velocity of that structural change.

Can Investment Themes Overlap?

The only thing better than one investment theme blowing on a company's business is multiple themes doing so. We recognize that several of our themes are complementary in nature, due in part to evolving technology, products and services. For example, it's easy to recognize that the world is moving towards mass digitization, therefore we can have a digital lifestyle investing theme. This theme can include e-commerce, the purchase and movement of goods and services to the customer. As consumers and businesses wade deeper into the digital world as part of our digital lifestyle investing theme, the growing number of connected devices opens the door for cyberattacks and privacy violations, so then we can have a cybersecurity investing theme.

The combination of multiple tailwinds offers a greater tailwind velocity to a company's business compared to a lone one, which should allow a well-positioned company to capture incremental revenue and profits at an even faster rate. Research from McKinsey & Company confirms this view, "In our experience, the most attractive opportunities are found when multiple themes converge and reinforce one another."