To better understand how thematic investing works, let’s take a look at large international brokerage firm BlackRock’s thematic investing philosophy as one example. Its philosophy for thematic investing focuses on a few different megatrends, all of which are driven by technological breakthroughs. These include:
Rapid urbanizationClimate change and resource scarcityShifting economic powerDemographic and social change
There’s a growing interest in thematic investing, as it fills a need to identify future drivers of return from equity investments. This gives investors the potential to outperform traditional broad indexes that reflect the movement of a market as a whole. Many investors will appreciate that thematic investing has the potential to help them position their portfolios for long-term growth opportunities. Why are some investors such big fans of thematic investing? Many consider it to be an innovative way to invest in the future while investing in the values that can help shape our world for the better. You also gain exposure to megatrends in your portfolio and possibly can capture companies poised for longer-duration growth across many different sectors and geographical areas.
How Thematic Investing Works
A typical thematic investing strategy looks at the following factors when choosing stocks, ETFs, bonds, mutual funds, and other investments:
Long-term trendsIdeasBeliefsValuesDisruption
Many thematic investing strategies focus on megatrends, disruption in major industries, sustainable investing, outcomes, and differentiated insights. Some investors may choose to invest in themes that align with their personal values or beliefs. Thematic investing allows you to channel your money where you believe the world is heading or where you hope it will move. An example of a value-based thematic investing strategy would be investing in women-run companies or companies that prioritize environmental sustainability. Of course, finding quality investments that align with the strategy of your investment plan while also reflecting your personal beliefs is usually the end goal of thematic investing. You can invest in thematic mutual funds or ETFs, which allow you to receive the benefits that come with professional investment research and management. Investing in mutual funds or ETFs enables you to tap into the efforts of professional portfolio managers and research teams who aim to create strong-performing funds. Investing in a thematic fund allows you to diversify your investment in a specific theme to limit risk.
Thematic Investing vs. Sector Investing
Because sector investing works in a similar way to thematic investing, it’s easy to get these two strategies confused. Sector investing involves targeting companies that fall into specific segments of the economy, such as information technology or energy. A thematic investing approach, on the other hand, can touch multiple sectors in an attempt to align with a market opportunity or specific objective. Let’s look at an example of how these two strategies compare in similar industry holdings:
Sector investing: Investing in companies that make up one of the following industries: semiconductor makers, cell phone tower operators, or social media companies.Thematic investing: Investing in some or all of the following sectors at once, as they align with a theme of disruptive communications: semiconductor makers, cell phone tower operators, and social media companies.
Is Thematic Investing Worth It?
Choosing a thematic investing path can have some negatives, though. According to investment research firm Morningstar, in the search for companies with the highest exposure to emerging themes and the greatest growth potential, thematic funds often invest in smaller, less liquid stocks and may pile into the same companies’ shares. Micro-cap stocks can offer promising upside, but limited liquidity means trading in them at short notice can be costly in terms of fees. And the growing popularity of thematic funds and ETFs, which tend to have narrow exposures and, if passively managed, must buy and sell in line with index rules, also has raised questions about liquidity. As thematic funds have grown and gained popularity, their holdings also have expanded—and these funds tend to gravitate toward similar names, Morningstar has found. In general, with their narrow exposure and higher risk profile, thematic funds are best used to complement, rather than take the place of an investor’s existing core holdings.
