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Thematic investing - what investors need to know

We take a closer look at thematic investing, what thematic ETFs are and how they work, and what investors need to consider.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Climate change catastrophes, space exploration and the rise of the robots. These are just a handful of themes that have gripped headlines in recent years. But while you might be interested in a theme, sometimes it can be tricky knowing if and how to invest in it.

That’s where thematic investing comes in.

What is thematic investing?

Thematic investing helps investors find companies that are part of long-term growing global megatrends. They’re often narratives about the ‘next big thing’ in 5, 10 or even 20 years’ time.

In the past, thematic investing has typically been a popular area for active funds – ones that aim to beat the returns of the wider market. However, a number of thematic Exchange-Traded Funds (ETFs) have launched in recent years, offering investors a new way to invest in their favourite themes.

This article isn’t personal advice. If you’re not sure if an investment is right for you, ask for financial advice. All investments and any income from them can fall as well as rise in value, so you could get back less than you invest.

What are thematic ETFs and how do they work?

Thematic ETFs are rules-based trackers, which invest in a basket of stocks with similarities to a certain theme, like clean energy, electric cars or artificial intelligence.

ETFs are a cheap and easy way to access a range of underlying stocks, without the dealing costs of buying them individually. But thematic ETFs are different to traditional ETFs.

Thematic ETFs aim to capture the performance of a chosen industry or trend, rather than track a major index like the FTSE 100 – an index of the UK’s largest 100 companies.

They typically use custom made benchmarks to invest in the areas investors want to, like robotics for example. A group of researchers will often select the companies deemed suitable to be included in the ETF. The privilege of researcher’s expertise can result in higher fees for the fund compared to a fund tracking a major index. Though the goal is to capture returns of a certain theme that help beat the market norm over time.

This can justify the higher cost if it works, but of course there’s no guarantee it will.

Digging into the details

So maybe you’ve got a theme in mind, the next consideration is the holdings. Thematic ETFs are labelled with simple titles like electric vehicles. But it’s important to check the fund does what it says on the tin.

ETFs allow investors to see a full breakdown of the holdings in the fund and how much is invested in each. This can be found on the ETF provider’s website. So you can look at each company, and whether you think they’re suitable for that theme. In the past, thematic ETFs have been accused of adding unrelated holdings to simply flesh out the portfolio, when there weren’t enough companies to represent a theme, so it’s important to check.

By not taking a closer look at the holdings, you could end up buying a fund that has more invested in holdings that don’t necessarily fit the theme. Depending on those companies, you might end up with a similar portfolio to more traditional ETFs, which simply track major indices, but for two or three times the cost.

Dangers of thematic investing

If a theme plays out as expected, the share prices of individual businesses capturing that trend tend to go up. The performance is often driven by the growth and momentum in the theme, rather than wider market movements. The problem with momentum trading is that a trend could be short-lived. Excitement in a new technology or theme can often be temporary.

Some companies in ‘the next big thing’ can be small, emerging companies. These companies can have good growth potential, but they’re also higher risk than investing in larger more established companies

Some niche themes have a much smaller investable universe. Investing in a small number of companies can also lead to a concentration within the fund towards only a handful of companies. Their performance will then ultimately drive the performance of the fund either up or down which can add risk.

Should you invest in thematic ETFs?

Thematic ETFs offer investors an easier and more diversified way to access a sector or trend using expert research compared to investing in individual shares directly. The opportunity for buying into exciting new trends might appeal to investors, but these investments come with additional risks and should be researched carefully.

Whatever your view on the next megatrend, investors should be cautious. Thematic ETFs might benefit from long-term structural trends, but there’s certainly no guarantee – we think investing anything over 5% of a portfolio in them is pretty adventurous

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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