Thematic investing using ETFs

Every so often a new theme or megatrend emerges in the world and exchange traded funds (ETFs) have become a popular vehicle for investors to take advantage.

 

  • What is Thematic investing?
  • What are thematic funds?
  • Popularity of thematic analysis
  • Replacing old stock classifications
  • Big themes for the 2020s

 

What is Thematic investing?

It is an investment strategy that seeks to identify big shifts in business and consumer behaviour and take advantage by investing in the companies driving the new trend - or benefitting from it.

The theme is often some kind of industry disruption in areas of demography, society, technology and the environment. But it doesn’t have to be, the theme can be a new industry unto itself.

For example, the megatrend of the iPhone - and understanding how important smartphones would become in our daily lives - saw Apple become the most valuable company on the planet.

Thematic investing is a similar concept to ‘top-down’ investing whereby an investor will look at the overall macro landscape and then gradually delve into specific sectors and companies that fit the view from the top. The main difference being that top-down investing tends to look at things like the credit and business cycles and levels of interest rates. It can be said that ‘thematic’ investing is much less reliant on economics.

 

Thematic funds

As a reminder, exchange traded funds are a collection of securities that trade on an exchange like a stock and have become the most popular way to invest for individual investors looking to ‘passively invest’ with lower fees. The most popular ETFs passively track an index like the S&P 500 or by traditional ways of categorising securities like via sector, size or geography.

BUT the ETFs grabbing all the headlines have been funds that track a megatrend or theme. This theme will likely span across the traditional categories just mentioned. The idea again, is not for the individual investor to pick the stocks that fit a theme but rather leave that decision to professional fund managers. The fund manager will set out the criteria for a stock to meet to be part of the fund. Then it simply for the investor to decide if they agree with the theme and the criteria, buy the ETF and passively invest.

 

Popularity

The amount of money pumped into thematic funds has tripled in the past five years to over $40 billion according to Morningstar.

In the United States Thematic funds have over $27 billion AUM (assets under management). But there is plenty of room for growth because thematic ETFs still only represent 0.5% of AUM in the US ETF industry.

3 Things to Know About Thematic Funds | Morningstar

The most popular segment of thematic investing has been in so-called disruptive technology - with robotics and artificial intelligence some of the most popular. This trend accelerated during the 2020 covid-19 pandemic when new technology was relied upon to replace traditional ways of interacting in economic and social settings.

 

thematic eft categories

 

Replacing old classifications

There is such a large universe of investment opportunities that it has always paid to breakdown where you want to invest by classifications like 'large-cap defensive' or 'European growth' etc. Such classifications are not going away because although imperfect, they serve a purpose of understanding trends within the market.

Breaking down investing ideas by theme has the advantage of being easier to grasp for non-professional investors that are interested in ETFs in the first place.

If the theme is a true ‘megatrend’ it will last for many years and permeate society, culture and business so deeply that many connected but diversified growth opportunities will present themselves. Investing in a theme gives an investor confidence in holding a portfolio with the long term view in mind. The theme can be invested in across industry, sectors and geographies.

 

Big themes for the 2020s

There are lots of themes and sub-themes and blends of themes. The advantage of this investing approach is that there is enough flexibility and variety to invest in an area that best reflects what you believe in.

 

thematic ETF AUM

 

How to play it

There are over 120 ETFs around thematic investing, here are 10 popular ones to get you started in your research.

 

10 popular thematic etfs

Source: New Academy of Finance

 

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