What are Thematic ETFs?

A great way to capture your interest in a specific industry, trend or class of shares when investing is through thematic ETFs. Not sure what they are? Here’s our deep dive into thematic ETFs and  whether they could be right for you.

What is a thematic ETF?

Thematic exchange traded funds (ETFs) are funds that allow investors to capture a specific theme in their portfolio such as clean energy, cyber security or artificial intelligence. The ETF holds companies that are influential in that trend or are believed to benefit from the growth of the trend.

Traditional ETFs look to achieve diversification at a low cost by following a broad market index, whereas thematic ETFs won’t allow the same level of diversification. By purchasing a thematic ETF, the growth of the ETF is tied to the underlying theme and trend.

The main goal for an investor to include thematic ETFs in their portfolio is to identify a major trend which will continue to grow, therefore growing their portfolio. This might include areas that focus on disruptive technologies, structural change or demographic changes and consumer behaviour.

Related reading: Highest return ETFs in Australia 2022

How do thematic ETFs work?

Most ETFs work by mirroring a weighted index of stocks, which is exactly how thematic ETFs work too. In purchasing one share of the ETF, you have a small stake in all of the companies the fund has exposure to, however it is more narrowly diversified across the companies in the themed ETF. One thing to look out for when it comes to thematic ETFs is the expense ratio. As the ETF is more actively managed than a passive ETF that follows an index, you’ll likely pay a management fee measured as a percentage of the money you have invested in the fund.

Pros of thematic investing

Some of the benefits to thematic investing include:

• It’s a low cost way to gain exposure to a wider range of companies within the chosen theme than you would if you invested in only one niche company
• The timing of purchasing the thematic ETF (i.e. buying and selling) are often less critical than other more seasonal or cyclical investments
• Doesn’t require you to research and pick a ‘winning’ company similar to active investing, only a ‘winning’ industry or trend.

Related reading: Canstar’s 2021 Award-winning ETF provider revealed

Cons of investing in thematic ETFs

However, there are some downsides to investing in thematic ETFs including:

• The higher risk nature of investing in one theme or industry, rather than more broadly diversified ETFs
• These types of ETFs can be more volatile due to their narrow diversification
• Thematic investing is solely forward focused, looking to make a future prediction on the outcome or impact of a specific trend, which means it may require more active management.

How could thematic ETFs fit in your investment strategy?

When choosing your investment strategy, you may have come across the term, ‘core satellite investing’ where the core, or majority of your portfolio is made up of passive and somewhat stable investments, such as index tracking ETFs, and the satellite is made up of more opportunistic growth opportunities that may be higher risk. The percentage allocation between the core and satellite depends on the risk profile of the investor.

Some investors may structure their portfolio under this strategy and use thematic ETFs as their satellite investment to capture a certain theme or industry they are interested in.

How to invest in thematic ETFs

Investing in thematic ETFs is relatively low cost (depending on the theme and platform), which allows for an arguably transparent way to gain exposure to the industries you believe will grow, make an impact or are shaping our world.

Some examples of Australian thematic ETFs include:

• ASX: CRYP – Invests in businesses in the technology of the emerging cryptocurrency economy
• ASX: DRUG – Exposure to global healthcare companies
• ASX: ESPO – Access to video game development companies, eSports and related software
• ASX:HACK – Invests in global cyber security
• ASX: IPAY – Exposure to companies innovating the global payments sector.

You can buy thematic ETFs the same way you purchase other ETFs or shares – through your online share trading platform.

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