Markets: News  

3 investing themes you need for the long run

NEW YORK (MarketWatch) -- Most investors understand the importance of good portfolio construction and broad diversification in an investment strategy. But the last few years have been tough for investors. Indeed, the current low-growth, low-rate environment continues to leave investors wondering how to build a portfolio that will perform well in the long term.

Thinking thematically, however, is a great way to uncover trends that are driving growth across multiple asset classes. And right now, there are some truly seismic global themes that could have an impact on your longer-term returns -- so long as you learn to live with, and buffer, the inevitable volatility.

Emerging markets

Emerging markets have always been a challenge for individual investors. For those that have invested over prolonged periods, the results have been positive. But too many try to time the market, chasing solid returns (e.g. 2010) one year only to bail out during the bumpiest periods (e.g. Q3 2011).

As difficult as it may be to withstand volatility, it's often better to stay the course, especially now with the explosive growth of the middle class in the emerging markets. This global population shift is arguably the most compelling investment theme today and should remain so for the next 20 years -- and is driving growth across several asset classes.

Countries such as Brazil, China, and Indonesia are shifting from export-driven or commodity-powered economies to ones that grow and are sustained through domestic consumption. Improving credit stories across emerging market economies are a compelling related theme, and can help buffer equity volatility.

There are many ways to capitalize on the growth of the emerging markets consumer. You can buy developed market equities that participate in this consumerism like big consumer goods companies all the way up the value chain to cars. (China recently surpassed the U.S. in car sales.)

It's also interesting to look at companies that play around the edges of this consumerism. Rising living standards can sometimes lead to poorer eating habits that result in higher incidences of diseases such as diabetes. Consequently, companies that produce life-saving drugs and other treatments for these kinds of diseases will experience a surge in customers. Because these companies are generally from developed markets, investing in them can help buffer the volatility generally associated with emerging market investments.

For something higher up the risk spectrum, equities of emerging market consumer companies are worth a look. This often requires working with a manager with good local knowledge. Buying a stock index in the emerging world doesn't always give you exposure to consumer-driven companies. For example, Brazil's major exchange, the Bovespa, is more than 40% energy and materials, and thus doesn't capture the forces driving the Brazilian consumer class.

It's also worth looking at emerging-market sovereign and corporate debt. Since 2007, nearly 100% of the more than 180 sovereign upgrades have been in emerging markets. Many emerging-market companies are in great financial health, too, making their bonds worth a look. That debt often yields a full percentage point above developed-market bonds of similar quality, albeit typically with more volatility.

The mistakes many investors make in emerging markets is they try to time the market; they invest mostly in the largest EM equities; and they do not consider EM debt. Given the volatility -- traditionally 50% higher than U.S. equities -- deciding when to get in can seem paralyzing. But for the longer term, a balanced approach that includes a broad spectrum of emerging- and developed-market equities, plus emerging-market debt and currency is a solid way to take advantage of this attractive growth story.

Technology innovation

Like the emerging markets, the tech sector has experienced above-average growth. Still, most market participants think technology companies are fairly valued to cheap relative to prospective earnings. In the case of technology, some of the more compelling pockets of growth are being driven by mega trends such as mobile, cloud computing, data center re-architecture, IT security, and "Big Data."

Businesses still remain the largest source of technology spending, but in my view, the global consumer more than ever has adopted technology (e.g. smartphones) and expects their employers to adapt to their preferences. This consumer/employee-to-employer relationship is driving a related trend some call the "consumeration" of technology.

While many investors are still scarred from the tech bubble bursting in 2000 to 2002, the sector is more mature than it was a decade ago. Still, technology continues to be a fast-moving industry where leaders can be replaced by innovative up-starts virtually overnight. For higher net worth investors, it is possible to invest in these early-stage companies through venture capital or by buying private shares. But this requires greater assets and often carries higher risk than traditional public market investing.

Passive management is viable, but you have to mindful of what's actually in these funds. Some of the ETFs have large position weights in only a relatively few stocks, while some include stocks in more mature areas such as PCs or invest in telecom.

Some form of active management with a professional money manager is encouraged. Successful management in the tech sector means spotting emerging trends, understanding which trends are durable, and having a sense of the viability of a company or product. Managers need to be flexible and cognizant of valuation because some of these stocks can get expensive, and missing earnings expectations coupled with a high multiple stock, can be a toxic combination. Active managers well-versed in the technology space are in a better position to identify when the kind of game-changing moments the tech sector is known for might occur.

Commodities

When I think of commodities, I consider commodities that are supply-constrained. That can include oil and other energy commodities, but it also means metals, such as palladium or copper, and agricultural products like corn.

Commodities are becoming increasingly supply-constrained in large part because of the demand and growth in the emerging markets. As China buys more cars, there's a need for more palladium for catalytic converters and oil for gasoline. As Brazilians buy houses, they need copper for wiring. As Indians become wealthier, they eat more sugar-rich products.

You can have the right idea in commodities, but implementing that idea can be challenging. There are a host of possible pitfalls to be wary of. Still, commodities have an important place in a portfolio for growth, diversification and inflation protection.

ETFs can get you into the commodities market, but you need to know what you're buying and what the implications are. In some commodity ETFs, there are special tax implications. And commodity ETFs don't always track what's happening in the market. Depending on the way an ETF is structured and the contracts it holds, it may react differently or even contrary to what the market is showing. In the fall of 2009, for example, natural gas spiked sharply, but some ETFs actually lost money.

Another way to invest in commodities is through natural-resources equities. But given cyclical nature of these businesses, investing in resource stocks can be more volatile than the standard equity market. But if you have a long-term horizon, global oil production and exploration, and mining and metals companies can be solid investments. These equities are also attractive for another reason: current M&A activity in the natural-resources industry. If you own these equities, you may get a nice premium if a company you hold is snapped up in the frenzy.

Investing thematically means looking at big-picture, secular changes and investing in related assets. The middle-class growth and corresponding consumption story has just begun and has a lot of potential upside. Thematic investing may have volatility along the way. But volatility can be your friend so long as you commit to a long-term relationship.