Introduction

Thematic ETFs are investments that focus on megatrends shaping society over the next decade and beyond.

Thematic ETFs are made up of a basket of publicly-traded equities that track specific megatrends such as clean energy, cybersecurity, sustainable food, clean water, AI and robotics.

They are one of the fastest-growing product segments over the last few years due to the technological and environmental shifts occurring across the globe.

According to Global X, the thematic universe can be broken down into three categories: 

• Disruptive technology 

• People and demographics 

• Physical environment 

Targeted exposure

By tracking a specific theme, thematic ETFs are more targeted than broader indices such as the MSCI World or S&P 500.

They tend to track indices that have smaller baskets and focus on pure-play companies aligned with a specific megatrend.

As they look to offer pure-play exposure, thematic ETFs are often more concentrated which can create additional risks versus broader benchmarks. Furthermore, most strategies invest in companies with anticipated future growth rather than immediate profitability.

This growth-stock bias leaves many thematic ETFs sensitive to macro factors such as high interest rates.

Investors must also navigate other factors such as market timing and overvaluation, often fuelled by market hype and liquidity concerns, particularly in ETFs focused on more specialised themes. 

Advantages of thematic ETFs

However, thematic ETFs democratise access to sophisticated market trends. Previously, identifying and investing in specific trends required deep market knowledge and extensive research.

With thematic ETFs, investors can now tap into well-crafted portfolios that reflect a particular theme, making it easier to invest in areas like biotechnology, cloud computing and eCommerce.

Alongside the potential for substantial returns, thematic ETFs also bring diversification benefits by spreading risk across a range of equities different from traditional benchmarks.

In the same breath, a niche focus on one theme can lead to concentration risks if the chosen theme underperforms.

Due to the subjective nature of defining a specific megatrend, index providers can have significantly different approaches when constructing benchmarks.

This can lead to wide performance dispersions across thematic ETFs, even in products that track the same megatrend, which is why investors must take a close look at the index methodology and underlying holdings. 

Final word

Overall, thematic ETFs can play a powerful role in portfolios by enabling investors to capture the trends of tomorrow. However, not all products are created equally so it is important to be aware of the potential risks as well.