Thematic ETFs are exchange-traded funds (ETFs) that concentrate on particular industries, trends, or themes like technology, sustainability, or developing markets. They provide a way to invest in themes or trends that align with your interests or investment strategy.
Thematic ETFs carry benefits and disadvantages. We'll look at both in this article.
Key Takeaways
- Thematic ETFs carry more significant risks but also potentially more lucrative rewards than ETFs with a broader focus.
- Since thematic ETFs concentrate on specific themes or trends, they often lack the diversification of more traditional ETFs, like those that track market indexes such as the S&P 500.
- Despite market challenges, thematic ETFs have had resilient growth.
- The popularity of some thematic ETFs has been boosted by their alignment with environmental, social, and governance (ESG) principles.
- Thematic ETFs can provide early exposure to emerging sectors such as renewable energy, robotics, and blockchain.
The Growth of Thematic ETFs
The number of thematic ETFs has increased in recent years, boosted by their appeal to investors wanting to tap into specific industry trends or sectors.
This growth has persisted despite challenges to sectors covered by thematic ETFs, underscoring the ongoing attraction of these specialized investment vehicles.
Thematic ETFs' growth has also been fueled by the alignment of some thematic ETFs with environmental, social, and governance (ESG) principles, which have surged in investor interest. It's also been driven by public interest in emerging technologies or practices.
These ETFs include sector-specific ETFs, ESG ETFs, and megatrend ETFs. Let's discuss each of these (and others) in the next section.
Types of Thematic ETFs
There are many thematic ETFs based on very niche topics. Below are some examples of the more popular or common types of thematic ETFs.
Technology ETFs
Technology ETFs concentrate on companies that are leading technological innovation. This can include firms in cybersecurity, artificial intelligence, blockchain technology, cloud computing, and many other fields of technology.
These ETFs give investors exposure to the rapid advancement of technology, which is often characterized by high growth potential but also increased volatility.
Healthcare ETFs
Healthcare ETFs are designed to capitalize on the healthcare sector's growth and the increasing global demand for health-related products and services. These ETFs typically invest in companies related to biotechnology, pharmaceuticals, medical devices, healthcare providers, and healthcare technology. Healthcare ETFs may also encompass areas like genomics and telemedicine.
ESG ETFs
ESG ETFs are designed for investors interested in socially responsible companies. They aim to include companies in their portfolios that meet specific ESG criteria, such as sustainable environmental practices, positive social impact, and strong corporate governance.
Note that companies in other ETFs could also double as an ESG-friendly addition. Clean energy ETFs are a more niche sector of the ESG ETF. They focus on companies involved in renewable and clean energy sources such as solar, wind, and hydroelectric power.
Consumer Trend ETFs
Consumer trend ETFs focus on investing in evolving consumer preferences and behaviors. These ETFs target companies at the forefront of consumer trends, such as the rise of wellness and healthy living, changing dietary preferences, or emerging fashion and lifestyle trends. Though they may offer attractive growth potential, trends come and go, as can the popularity of the underlying companies.
Emerging Market ETFs
Emerging market ETFs offer investors exposure to undeveloped or underdeveloped economic markets. Such economies are typically characterized by rapid economic growth and development. These ETFs may cover regions such as Asia, Latin America, or Africa, providing access to enormous growth potential. However, they often come with higher risk due to factors such as currency fluctuations and political instability.
On January 11, 2024, spot Bitcoin ETFs began trading in the United States. These thematic ETFs offer investors a convenient, simple, and regulated way to gain exposure to the price movements of bitcoin, without the cost, time, and effort involved in buying the digital currency directly.
Benefits of Thematic ETFs
Targeted exposure: Thematic ETFs invest for exposure to specific trends or fields, such as blockchain or crypto. This can be particularly beneficial for those who strongly believe in the potential of a certain theme, like robotics or renewable energy.
Diversification: Thematic ETFs typically invest in companies across several sectors of the economy. This spreads risk and provides diversification despite the emphasis on a specific field, such as robotics. For example, a thematic ETF for technology may own hardware and software development companies, start-ups, and blue-chip stocks.
Flexibility: Thematic ETFs trade on an exchange like common stock, meaning investors can buy or sell shares at any time during the trading day at the market price. Thus, investors, particularly active traders and those more interested in speculating than in long-term investing, can react quickly to changes in the market.
Early access: Thematic ETFs provide a more straightforward way to invest in newer and fast-growing sectors like artificial intelligence, blockchain, or renewable energy. They allow investors to choose the niche areas that they wish to invest in.
Professional management: Those interested in robotics, ESG-managed firms, or other niche themes often find it difficult to get up to speed in such specialized areas so that they know where to invest.
Thematic ETFs are managed by experts who should understand their respective fields well, including their challenges and where growth can be found. This professional oversight can be a boon for investors, given the necessity of specialized knowledge.
Risks of Thematic ETFs
Concentration: While thematic ETFs offer exposure to specific sectors or a trend, this focus can mean concentration risk. The thematic ETF could suffer significant losses if a particular theme or sector experiences a downturn.
For example, consider how the different parts of the real estate market may move as a whole. Investing across a variety of companies may not offer enough diversification to counter broad-based price movements.
Market timing risks: Predicting the success of the trends focused on by thematic ETFs can be difficult, and if your (or professional management's) timing is off, you could face significant losses. In addition, by the time the thematic ETF is created, the market may have already moved on or matured.
Hype and overvaluation: Investors should be wary of funds that are part of speculative bubbles in trendy themes that fail to pan out. You must truly understand what a thematic ETF is invested in. Instead of getting caught up in the hype surrounding an ETF, make sure you understand specifics, such as the portfolio holdings and their weights.
Liquidity risk: Some thematic ETFs, particularly those focused on niche themes, may not be as heavily traded as more traditional ETFs. This can result in liquidity risk, where an investor might find buying or selling shares difficult without affecting the market price.
Pros & Cons of Thematic ETFs
Pros
Enable investment in specific sectors or trends.
Spread risk across several sectors or many companies.
Can be bought or sold at any time during the trading day.
Handle research into firms that best fit and are most likely to succeed.
Cons
High exposure to a single sector can lead to significant losses.
Difficult to predict if it's too late to profit from the success of emerging trends.
Potential lack of liquidity can affect your ability to buy and sell.
Overvaluation can result as speculators invest in fads.
How To Choose a Thematic ETF
Thematic ETFs can be a valuable investment for those looking to capitalize on specific trends or sectors. However, they may involve more complex research compared to traditional ETFs. When considering and researching thematic ETFs, think about these key aspects:
Investment Objective
Start by understanding the investment objective of the thematic ETF. Ensure that the theme aligns with your investment goals and risk appetite. Thematic ETFs can be quite specialized, and their objectives can range from high-growth opportunities to socially responsible investing. It's crucial that the ETF theme matches your financial objectives.
Fund Performance
Historical performance is a key factor, but it's important to remember that past performance is not a guarantee of future results. Analyze the ETF's historical returns to get a sense of how it has performed in different market conditions. Compare the ETF's performance against relevant benchmarks to assess its relative strength.
Fund Holdings
Examine the companies in the ETF's portfolio. Are these companies leaders in their respective fields, or are they promising up-and-comers? Remember that there may be different thematic ETFs for the same niche (e.g., different technology ETFs). If you like the theme but don't like or understand the holdings of a particular thematic ETF, consider searching for another that's similar.
Expense Ratio
The expense ratio represents the annual costs associated with managing the ETF and is expressed as a percentage of the fund's assets. Lower expense ratios generally mean more of your investment remains in the market, allowing for greater potential returns.
All else being equal, because thematic ETFs are more specialized and require more oversight from a portfolio manager, expense ratios are generally higher than traditional ETFs.
Liquidity
Liquidity is also an important consideration, as it affects your ability to buy or sell shares. Check the trading volume of the ETF. Higher trading volumes typically indicate greater liquidity. Greater liquidity makes it easier to enter or exit positions. Low liquidity can result in wider bid-ask spreads, potentially leading to higher trading costs.
Management Team
Evaluating the expertise of the ETF's management team is critical. Look into the backgrounds and experience of the fund's managers. Experienced managers are better equipped to navigate market volatility and manage the risks associated with specific themes or sectors.
Different managers may also have different experiences in niche markets, so consider not only their investment experience but also their exposure to the underlying ETF theme.
Are Thematic ETFs for Long-Term Investing?
This depends on the specific ETF and your individual financial situation and goals. While some thematic ETFs may offer strong growth potential over time, they also have risks and may be more volatile than broader market ETFs. It's always prudent to consult with a financial advisor before making investment decisions.
What Is the Difference Between Thematic ETFs and Sector ETFs?
While both concentrate on specific market areas, sector ETFs focus on single sectors like finance, healthcare, consumer goods, or real estate. Thematic ETFs invest more broadly to tap into overarching trends or themes that appear in several sectors.
For example, the Global X Robotics & Artificial Intelligence ETF (BOTZ) includes firms from various sectors and industries within them that use or build robotics and AI technologies. Thus, it might own shares in a healthcare company using robotics for surgeries and diagnostics and in firms using artificial intelligence for smart homes.
Do Thematic ETFs Pay Dividends?
Some do. It depends on the individual companies within the ETF's portfolio. The ETF will distribute dividends to shareholders if it holds companies that pay dividends.
How Frequently Are Thematic ETFs Rebalanced?
This varies. Some may rebalance quarterly, while others do so annually. The prospectus of the ETF should provide its rebalancing schedule.
How Do ESG ETFs Work?
ESG has been an increasing part of investment decisions for some institutional investors and many individuals. Some thematic ETFs specifically target companies that meet certain ESG criteria within given sectors or fields, while others are broadly trying to capture ESG-managed firms across the economy. These ETFs incorporate ESG factors into their investment criteria to varying degrees. If you're interested in ESG, you should check the ETF's prospectus for more details.
The Bottom Line
Thematic ETFs can be attractive investments because they offer potential gain from evolving trends and aren't restricted by a single sector focus. They provide the opportunity for diversification and growth.
They also have a higher risk than traditional ETFs because of their focused nature.
As with any investment, it's crucial to complete comprehensive research and understand your risk tolerance before diving in.
