Thematic Investing-Meaning, Advantages & Disadvantages

Quite often, products and services of various companies have an influence on us or their missions align with our beliefs. For the purpose of investing however, it becomes difficult to pick a stock within that sector to invest in. Thematic Investing is a method that enables you to invest in long-term trends or themes that match your investment objectives.

Thematic Investing is mainly characterized as a top-down approach that capitalizes significant opportunities or popular trends which may have strong growth in the coming years. It attempts to identify the broader macro-level trends and the businesses and sectors that stand to benefit from the materialization of those trends. 

Understanding the Themes

There are various types of themes readily available that are chosen by fund managers using a systematic approach. Some notable themes are ESG (Environmental, Social and Governance Factors), Disruptive Technology (eg. Artificial Intelligence, Blockchain, Machine Learning), Shariah (based on Islamic beliefs and principles), Healthcare, Infrastructure, megatrends (based on demographic factors). The stocks that match with the broader theme are then included to become a part of the portfolio.

Other than this investors can create their own themes based on their trends, analysis of the economy, and preferences such as creating a them based on Covid-19, where all the stocks concerning the pandemic, e.g., Insurance, Pharma, Hospitals, IT and other relevant sectors can be a part of the theme.

Creating Your Own Theme

Thematic Investing aims to reduce the effort required to select individual companies but it is advisable to research well about the theme you are interested in and make sure that the required risk matches your appetite. You can create your thematic portfolio with the help of the following steps:

1. Understanding and Identifying the trend

The primary step for thematic investing is to study developments in society, technology, economics or specific regions and choose a theme or trend expected to gain prominence in the future based on the conclusion of the study. 

One needs to also understand whether the trend is short-term, structural or speculative and how any changes in the trend will impact the stocks. Sustainability of the trend is of crucial importance.

2. Identifying the Sectors/Companies

Once the theme is finalized investors can then start looking out for the various sectors that can be a part of the broader theme for investing. The investors can then narrow down the selection process by selecting the top-performing companies or market leaders from those sectors. They can also look out for some value stocks that may prove to have a good upside potential.

3. Fundamental Analysis 

Selecting companies just because they can be a part of the particular theme will not be enough. Investors should check whether the company is fundamentally profitable for investing. Parameters like the efficiency, profitability, risk, performance, quality of management, earnings estimate, etc. should be taken into consideration.

4. Assessment and Monitoring

After creating a successful theme based investment portfolio, investors should not fail to monitor it and reconstruct or rebalance as per the market conditions and changing trends. Performance evaluation is a must to understand the profitability of your investment.

Thematic ETFs

1. ARK Innovation ETF (ARKK)

The fund seeks long-term growth of capital by actively investing in domestic and foreign equity securities of companies that are relevant to the Fund’s investment theme of disruptive innovation. Disruptive innovation includes those companies that rely on or benefit from developing new products or services, technological improvements, and advancements in scientific research. 

Expense Ratio: 0.75% 

2. iShares Global Clean Energy ETF (ICLN)

The Fund seeks investment results that generally correspond to the price and yield performance, before fees and expenses, of the S&P Global Clean Energy Index. The Index is designed to track the performance of approximately 30 of the most liquid and tradeable global companies, which represent the listed clean energy universe.

Expense Ratio: 0.42%

3. Emerging Markets Internet & Ecommerce (EMQQ)

The fund seeks to offer exposure to the growth in Internet and Ecommerce activities in the developing world as middle classes expand and affordable smartphones provide unprecedentedly large swaths of the population with access to the Internet for the first time. EMQQ ETF tracks an index of leading Internet and E-commerce companies, including online retail, search engines, social networking, online video, e-payments, online gaming, and online travel.

Expense Ratio: 0.86%

4. iShares Agribusiness Ucits ETF (SPAG) 

The Fund seeks to track the performance of an index composed of companies related to global agriculture businesses. It provides exposure to broadly diversified agricultural business companies and enables them to get exposure in global companies hassle-free.

Expense Ratio: 0.55%

5. Elwood Global Blockchain Ucits ETF (BCHM) 

The fund offers exposure to global companies in developed and emerging markets that participate or have the potential to participate in the blockchain ecosystem. The performance of the Elwood Blockchain Global Equity Index is used as a reference. Accordingly, constituent weightings are subject to liquidity and UCITS constraints. The fund aims to achieve its objective by buying and holding all the securities in the Reference Index in their respective weightings as far as possible and practical. 

Expense Ratio: 0.65%

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Advantages of Thematic Investing

Thematic investing can capture interesting societal or technological trends, giving investors quick access to a group of companies representing such changes. It helps to capitalize on future trends. It helps to invest in ‘Businesses of the Future’ because of its forward-looking nature. It is readily customizable, with high flexibility providing potential for growth.

Thematic Investing can act as a portfolio hedge, Since it constantly focuses on trends and disruptive changes in the world. Investors can generate alpha (excess return over its benchmark) with the help of thematic investing. Thematic investing is convenient and hassle free with the help of thematic ETFs. For instance, instead of buying a number of companies in a niche space that appears to be growing, an investor can simply buy an ETF and gain exposure to the theme without investing much capital or incurring brokerage and other transaction costs.

Disadvantages of Thematic Investing

Many of the benefits of thematic investing can also come with adverse outcomes. For example, according to the Wall Street Journal, about 28% of the US-based thematic ETFs launched before 2012 have closed. In Europe, that number is 80%. In addition, there is a high risk in thematic funds as you are dependent on a specific idea or theme, which may or may not fetch high returns, especially during various market cycles.

Themes of your investment based on trends can phase out quickly and may have high volatility. It may also happen that the theme you’re interested in has been already priced in or, at times, is overpriced. In the case of thematic ETFs, the fund’s structure may not accurately reflect the investor’s bet. Many of these thematic ETFs end up performing poorly because sometimes, by the time the ETF hits the market, the theme has already played.

The Bottom Line

Thematic funds are usually not different from Mutual funds or ETFs. The only difference is that they are merely based on a theme that varies from a multi-sector, multi-economic trend, etc. Since it offers diversification benefits and higher returns, it is more likely than not that it will outperform the other asset classes like gold and fixed deposits. However, it is imperative to know that exposure to a specific theme has added risks involved too. Therefore, creating a diversified portfolio with minimal exposure to thematic funds/businesses and investments is advisable.

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