What are Thematic ETFs? Investing Explained

In this series, we break down the jargon and explain a popular investment term or theme. Here it is: Thematic ETFs.

What are they?

ETF stands for exchange-traded fund, so called because investors can buy or sell at any time. Other funds only trade once a day.

A thematic ETF is designed to capitalize on a shift in a broad “mega theme” such as big data, fintech, mobility or robotics.

They can also choose a narrower theme. For example, the mega theme of robotics includes themes such as artificial intelligence (AI) and drones.

Whichever mega theme you choose, there are a wide variety of funds available, from medical cannabis to pet care.

How do they work?

Managers do not choose individual stocks. Instead, they take a passive approach and follow a specially constructed index.

Companies are weighted, in some cases by market value, so that larger companies make up a larger portion of the index. But the biggest weights can also be assigned to companies that derive the most revenue from the theme.

Does AI have a role?

Yes. For example, JP Morgan Asset Management has its own system – Themebot – that helps its managers cover 13,000 companies around the world, narrowing down potential opportunities.

Themebot was used for its Climate Change Solutions ETF, which launched in the UK last year.

What about costs?

ETFs have much lower annual management fees than active funds where managers pick the stocks. The fee can be 0.05 percent compared to 0.50 percent to 1 percent for an active fund. But thematic ETFs are more expensive.

How big are the risks?

There is a risk of over-concentration in one area – sometimes an area that is also already over-hyped. As a result, investors can buy at the peak. Since most ETFs are technology oriented, they have been adversely affected by rising interest rates, although some are starting to recover.

What are the known funds?

Around $79 billion is invested in this type of ETF worldwide. But the most famous — and most controversial — is the $7.3 billion ARK Innovation ETF, run by Cathie Wood, one of America’s most watched managers.

In 2022, the fund’s value fell by two-thirds due to its holdings in TV streaming company Roku and Tesla, sparking a firestorm of criticism over Wood’s strategy. But the fund is up 36 percent over the past month. Wall Street is curious to see what happens next.

You got me interested…

Thematic ETFs can be a way to invest in something you’re passionate about, such as clean energy or electric vehicles.

But the advice is that these funds should only be a small part of a portfolio unless you have deep pockets.