Thematic Investing

What Is Thematic Investing?

Thematic investing is an investment approach that seeks to outperform the general market by buying stocks and other financial assets that the investor or portfolio manager believes will benefit from widespread economic, social, financial and technological trends over the long term.

Thematic investing goes beyond sector investing, in which a mutual fund or exchange-traded fund (ETF) invests in securities in a particular industry. Rather, thematic investing can cut across several sectors, countries, and many companies and asset types if the portfolio manager believes they will all benefit from the trend.

Among the most common and popular trends currently are cloud computing, blockchain technology and cryptocurrencies, climate change and clean energy, the rise of China, robotics and artificial intelligence, cybersecurity, and electric vehicles. According to one estimate, there are now more than 40 thematic ETFs, and assets in them has reached $133 billion, up from $27 billion before the onset of the COVID-19 pandemic in 2020.^[1]

Thematic investing has largely followed the popularity of environmental, social, and governance (ESG) funds, which themselves follow a theme, namely investing in companies they consider to be engaged in socially responsible and sustainable behaviour. Thematic funds are more likely to emphasize financial and investment performance, althouguh ESG funds believe that good corporate behaviour usually translates into better financial performance.

Popular Thematic ETFs

The number of thematic ETFs and the amount of money invested in them has grown exponentially in a very short time. Here are some of the largest and most popular ones.

ARK Innovation (ARKK)

This fund is actively managed by Cathie Wood, founder and CEO of Ark Invest, who has achieved rock star status among her many followers. The fund invests in what the company calls ''disruptive innovation,'' which it defines as "the introduction of a technologically enabled new product or service that potentially changes the way the world works." The fund currently has $25 billion under management.^[2]

Its five largest holdings as of 18 August 2021 are Tesla, which accounts for more than 10% of the portfolio; and Teladoc, Roku, Coinbase and Unity Software, each of which accounts for about 5% of holdings. All five of these companies are in completely different industries, so the fund's theme is rather broadly defined.^[3]

The fund invests in a wide variety of sectors, including cloud computing (13.7% of portfolio), e-commerce (11.9%), digital media (11.3%), gene therapy (6.6%) and mobile communications (6.0%). All percentages are based on figures as of 30 June 2021.^[4]

First Trust Cloud Computing (SKYY)

First Trust Cloud Computing invests in companies in the cloud computing sector, including data storage and computing power. Its top five holdings as of 4 May 2021 were Oracle, VMWare, Alphabet, Rackspace Technology, and Arista Networks.^[5]

Global X Robotics & Artificial Intelligence ETF (BOTZ)

This fund invests in companies in robotics, artificial intelligence, and autonomous driving. Its top five holdings were NVIDIA, ABB, Intuitive Surgical, Fanuc, and Keyence.^[5]

First Trust NASDAQ Cybersecurity ETF (CIBR)

This fund tracks the Nasdaq CTA Cybersecurity Index and owns cybersecurity companies that protect networks, computers and mobile devices. Its top five holdings were CrowdStrike, Splunk, Accenture, Zscaler, and Cisco Systems.^[5]

iShares Global Clean Energy ETF (ICLN)

Sponsored by BlackRock, this fund tracks an index of global clean energy companies, including those involved with solar, wind and other renewable sources. Its top five holdings were Vestas Wind Systems, Orsted, Enphase Energy, Xcel Energy, and Iberdrola.^[5]

Advantages And Disadvantages Of Thematic Investing

Like most other investments and investment strategies, there are several positive and negative aspects to thematic investing.

Generating Alpha

The goal of most thematic funds is to outperform the general market—i.e., generate alpha—by investing in those areas believed to have the most promise. While that may not always prove to be the case, many funds have indeed been able to outperform the major stock market indexes, such as the S&P 500, by investing in these areas.^[6]

Volatility

Thematic funds are often highly volatile, recording huge positive returns in one period and sharply negative returns in another. Many of the companies that thematic funds tend to invest in are relatively new and don't have a long track record of success. They are also often engaged in more speculative endeavors. As a result, their financial performance, and thus stock performance, can veer sharply up and down from quarter to quarter. Investors in these funds therefore have to be comfortable with a bumpy ride.

Diversity

Like other ETFs and mutual funds, thematic funds give investors the opportunity to avoid single stock risk by investing in a pool of different securities, thus spreading the risk over many companies. For example, rather than investing in one cybersecurity company, the investor would get some protection by investing in a fund that contains not only companies engaged in that field but also those in related sectors.

However, some thematic funds include a relatively few number of securities, compared to some index funds that track a wide swath of the market and include hundreds of stocks. For example, the ARK Innovation ETF included only 49 holdings as of 19 August 2021, and the top 10 holdings accounted for more than half of the portfolio. By contrast, funds that track the S&P 500 includes 500 stocks, while some funds include many more holdings.^[3]

Flexibility

On the other hand, thematic funds often invest in many widely different companies and industries, which can add diversity. That gives the portfolio manager wide discretion in what they choose to invest in, enabling them to shift away from out-of-favour companies and into those with more promise. This extends to the types of securities the fund can invest in, not just the industry. The fund may also be able to invest in bonds and alternative investments, not just stocks.

For example, ARKK has holdings in electric vehicles (Tesla), electronic payments (Square), medical care (Teladoc), real estate (Zillow), and cryptocurrencies (Coinbase).^[3]

Staying Power

While portfolio managers and the people who invest in their funds may believe that certain trends and themes have staying power, that's not always the case. One trend may look like a good long-term bet today but that may not be true a year or two down the road. It could merely be a fad. Some funds also don't last due to poor performance.^[7]

For example, in mid-year 2021, China's government began a crackdown on some of the country's biggest technology companies, which provoked a major sell off of those companies. Some Chinese stocks also weakened due to concerns about reduced economic growth in the country.^[8]

As a result, a serious and successful thematic investment strategy requires a good deal of research, not simply selecting a theme that is hot today but won't stand the test of time.

Summary

Thematic investing is a strategy that seeks to outperform the market averages by investing in companies that are expected to benefit from widespread economic, social, financial and technological changes and trends. Unlike sector investing, thematic investing can cut across several sectors, countries, and many companies and asset types.

Some of the most popular trends are cloud computing, blockchain technology and cryptocurrencies, climate change and clean energy, robotics and artificial intelligence, cybersecurity, and electric vehicles. The number of such funds and the money invested in them has grown sharply in the past few years.