Exchange-traded funds (ETFs) are extremely versatile. They allow investors to purchase different equity styles, geographies, sectors or industries all in a single ticker. For example, investors can easily buy value stocks, U.S. market stocks, technology sector stocks or regional banking industry stocks with an ETF.
Investors can buy shares in another special type of equity ETF – the thematic ETF. Instead of investing in styles, geographies, sectors or industries, these ETFs target big ideas and long-term trends. If you're looking to invest for growth and focus on futuristic innovation, these ETFs might be what you're looking for.
Investing in thematic ETF isn't always straightforward, given the vast number of options out there competing for your money. This guide will help you understand the best ways to select the ideal thematic ETF for your portfolio.
What are Thematic ETFs?
According to BlackRock, a thematic ETF holds a basket of stocks that is "positioned to benefit from potential shifts in technology, society, the environment and demographics over time."
The key to understanding thematic ETFs is visualizing them as a way to take part in structural changes in various markets, sectors and industries. For example, investing in a thematic ETF that tracks electric vehicles (EVs) is essentially a bet on the automotive industry and consumers shifting from internal combustion engines to electric.
Thematic ETFs are a relatively new invention, but the idea of thematic investing is not. Historical examples include people who invested in Ford Motor Co. (NYSE: F) when cars started to replace the horse-drawn buggy and people who invested in e-commerce companies like Amazon Inc. (NASDAQ: AMZN) during the dot-com bubble.
However, picking the right stocks to take part in a thematic megatrend can be difficult. After all, for every successful company that thrives during these structural changes, countless others fall by the wayside or go bankrupt. Picking winners ahead of time is hard, especially when it comes to high-growth, disruptive innovation.
This is where a thematic ETF can come in handy. By holding a portfolio of companies that participate in a specific thematic megatrend, these ETFs offer higher diversification. By buying one of these ETFs, investors can bet on an overall thematic megatrend instead of a single company, which can reduce risk. Thematic ETFs are a straightforward way to invest in an innovative trend.
Types of Thematic ETFs
Thematic ETFs are mostly categorized by their underlying theme, idea or trend. There's no limit to the types of thematic ETFs that could exist, as new trends will constantly come and go. Here's a breakdown of some of the current and notable trends on the market, along with thematic ETFs that fall into each category:
- General innovation: These ETFs target a diversified portfolio of companies involved in multiple disruptive or innovative niches. A great example is the ARK Innovation ETF (NYSEARCA: ARKK), which holds stocks involved in genomics, automation, robotics, AI and fintech.
- Clean energy: These ETFs target companies involved in the development, production or distribution of clean energy sources. They can be a high-growth alternative to traditional energy sector ETFs that mostly hold fossil fuel companies. Examples include the iShares Global Clean Energy ETF (NASDAQ: ICLN), the Invesco Solar ETF (NYSEARCA: TAN) and the First Trust Global Wind Energy ETF (NYSEARCA: FAN).
- Cybersecurity: These ETFs hold companies that develop or provide cybersecurity software and services, which have become increasingly important in today's connected world. Examples include the First Trust NASDAQ Cybersecurity ETF (NASDAQ: CIBR), the ETFMG Prime Cyber Security ETF (NYSEARCA: HACK) and the Global X Cybersecurity ETF (NASDAQ: BUG)
- Electric vehicles: These ETFs hold companies that manufacture EVs or companies that produce raw materials or components essential to their supply chains. Examples include the Global X Lithium & Battery Tech ETF (NYSEARCA: LIT), the Global X Autonomous and Electric Vehicles ETF (NASDAQ: DRIV) and the iShares Self-Driving EV and Tech ETF (NYSEARCA: IDRV).
- Automation and robotics: These ETFs focus on companies that produce the hardware and software needed to develop automation and robotics solutions. Examples include the ARK Autonomous Technology & Robotics ETF (BATS: ARKQ), the ROBO Global Robotics and Automation Index ETF (NYSEARCA: ROBO) and the Global X Robotics & Artificial Intelligence ETF (NASDAQ: BOTZ).
Other thematic trends tracked by ETFs include water, genomics, infrastructure, next-generation internet, fintech, energy transition, video games and marijuana to name a few. As time goes on, more thematic mega-trends will emerge, with new ETFs popping up for investors to bet on them.
Benefits of Thematic ETFs
Thematic ETFs are popular among younger, higher-risk tolerance investors for a number of reasons. The main benefits these ETFs offer include:
- High growth potential: Thematic ETFs can outperform dramatically when economic conditions are favorable or if their underlying theme experiences sudden growth and attention.
- Transparency: The holdings of most thematic ETFs are published on a daily basis, which makes it easy for investors to keep track of what they're invested in.
- Simplicity: Purchasing shares of a thematic ETF is easier than manually identifying stocks and conducting individual analyses of each.
Drawbacks of Thematic ETFs
Not all investors may find a thematic ETF appropriate for their portfolio. Some reasons investors may avoid thematic ETFs include:
- Higher fees: On average, thematic ETFs tend to charge much higher expense ratios than broad-market index ETFs.
- Under-diversification: Thematic ETFs tend to hold a concentrated portfolio of stocks from a particular niche or trend, which can cause them to be under-diversified compared to a broad-market index ETF.
- Underperformance: Thematic ETFs may underperform the overall market for extended periods of time, especially if their underlying trend fails to play out as anticipated.
Compare ETF Brokers
Investors looking to research and choose the best thematic ETFs can use Benzinga to compare the available selections available on the market. Here is a list of brokers that support thematic ETF trading and offer research tools to help investors select the right one.
Frequently Asked Questions
Are thematic ETFs a good idea?
Whether thematic ETFs are a good idea depends on a particular investor’s risk tolerance and objectives. For those willing to bet on the growth of a specific trend, idea or niche, a thematic ETF is a great alternative to picking individual stocks. However, it carries greater concentration risk than the average index ETF. In addition, investors who prioritize low fees may not like thematic ETFs for the higher expense ratios they often charge.
Are thematic ETFs a safe investment?
Thematic ETFs are not a safe investment. Due to their concentrated nature, these ETFs tend to be highly sensitive to economic variables like inflation and rising interest rates. In addition, legislation or competitive risks that impact their specific trend, niche or industry can deal thematic ETFs a sharp blow. There’s also no guarantee that the trend a thematic ETF bets on will prove to be sustainable and grow steadily in the future, given that the potential for disruption is always present. For those looking for a safe investment, an alternative like short-term Treasury or money market ETFs may be better than a thematic ETF.
About Tony Dong
Tony Dong, MSc, CETF®, is a seasoned investment writer and financial analyst with a wealth of expertise in ETF and mutual fund analysis. With a background in risk management, Tony graduated from Columbia University in 2023, showcasing his commitment to continuous learning and professional development. His insightful contributions have been featured in reputable publications such as U.S. News & World Report, USA Today, Benzinga, The Motley Fool, and TheStreet. Tony’s dedication to providing valuable insights into the world of investing has earned him recognition as a trusted source in the finance industry. Through his writing, he aims to empower investors with the knowledge and tools needed to make informed financial decisions.