The beauty of ETFs is that they have democratized many asset classes. From commodities and esoteric bonds to small-cap and international stocks, investors have the ability to add plenty of new asset classes to their portfolios. For advisors, it allows them to build easy-to-replicate strategies and track models, leading to better long-term outcomes.
It also allows investors and their advisors to build models based on themes and future trends.
With countless ETFs tracking various themes and trends, it’s easy to incorporate these funds into a model portfolio to gain benefits, diversification, and potential long-term gains. And with a little initial legwork, adding a touch of thematic investing to a model can produce great long-term results.
Thematic Investing in a Nutshell
There are many styles of investing. But one that has caught on in spades in recent years is thematic investing. According to BlackRock, over the last 10 years, assets managed in specific U.S.-listed thematic funds have grown nearly ten times from $9.7B in 2014 to $92.7B in 2024. Part of the evolution of the style has been the proliferation and growth of exchange-traded funds (ETFs).
At its core, thematic investing is buying stocks, bonds, and other assets centered on a specific trend. This trend could be anything — technology advancements such as artificial intelligence and robotics or an aging population. The idea is that investors find investments that operate within these trends to seek returns as the trend plays out over the long haul.
The key to thematic investing is that it’s not sector-based investing.
For example, in the case of artificial intelligence, it’s not just tech stocks that will benefit. Yes, software and semiconductor firms are AI plays, but the utilities that are powering the data centers, the REIT real estate owners of the data centers, and consumer staples that are using AI to develop new products can also benefit. The base of thematic investing is that investors focus on a holistic and encompassing approach to the trend. In that, they buy all the stocks or assets that encompass the idea, providing a different level of diversification for a thematic portfolio.
Aside from the diversification aspects, the guiding principle of the style is getting meaningful returns from a portfolio. Depending on the theme and length of the trend, investors can potentially score market-beating returns for years. This chart from AllianceBernstein shows that extra returns form some of the biggest themes of the last few decades.
Source: AB.com
Moreover, they might be able to do so with less volatility and risk. In the case of the AI, for example, semiconductor stocks tend to be volatile. However, utilities are less so, with steady dividend payments providing much of the return. Together, they could allow a smoother overall ride. Another could be advanced cancer treatments, with steady big-name pharma stocks buffering smaller biotech names.
Building a Thematic Model
The beauty is that the growth of ETFs, thematic investing, and following trends are as easy as buying a single ticker. Today, numerous funds — both active and passive — cover a wide range of themes and trends. With this growth, building a thematic model or adding a thematic sleeve to a traditional model portfolio is easy.
However, there are few guidelines.
The biggest question investors need to ask is whether the theme is an enduring trend or simply a passing fad. Wall Street and investors love hype. And it’s important to find real themes backed by real data and potential. Now, this may be easier said than done. But it’s crucial to finding long-term trends that have real staying power.
The next question comes down to investability. Is it even possible to own and participate in the theme or trend? Overly narrow or constrictive themes without a large enough opportunity set might not even be possible to focus on or add to a portfolio — even with ETFs.
Once that is done and investors have decided on a theme or several themes that fit, then comes the allocation part. A recent Goldman Sachs paper shows that ideal exposure to thematic trends.
Looking at standard equity portfolios with various levels of thematic exposure from 2013 to 2020 found that the sweet spot for most portfolios is around 10% to 20% of dedicated weighting to thematic investing in a standard equity portfolio. This can provide 1 to 2% in excess returns above a standard market-cap-weighted index with only increased risk by 2 to 4%. That’s a good trade-off for excess returns. Goldman notes that this sweet spot provides some safety if investors get the theme or trends wrong. 1
Additionally, when it comes to thematic investing, being an early adopter doesn’t necessarily matter and can only increase risks. Hoping on a long-term theme in inning 3 or 4 isn’t necessarily such a bad thing. Trends can already be in place, and while the “fast money” could have already been made, the longevity of a trend will carry portfolios through.
Putting This Into Practice
As we said at the opening, the growth of ETFs has made thematic investing a simple task. And it’s this investment vehicle that investors should use in their model portfolios to add a sleeve of trend-focused assets.
After investors identify a theme — or better still, themes — that they want to follow, adding the 10 to 20% weighting can be simply as easy as buying a ticker or two. As with the rest of a model portfolio, investors can quickly rebalance, adjust, and even sell out of a theme completely as returns permit. Moreover, the overall volatility of a thematic investing could help on the tax front with tax-loss harvesting — selling losing themes or long-term trends currently in a downturn.
Popular Thematic ETFs
These ETFs are selected based on their assets under management and represent some of the largest thematic ETFs around. They are sorted by their 1-year total return, which ranges from -0.7%% to 25%. They have expense ratios between 0.51% and 0.75% and assets under management between $1.23B and $9.72B. They are currently yielding between 0% and 5.7%.
| Ticker | Name | AUM | 1-year Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| FDN | First Trust Dow Jones Internet Index Fund | $6.68B | 25.3% | 0% | 0.51% | ETF | No |
| AIQ | Global X Artificial Intelligence & Technology ETF | $2.48B | 24.9% | 0.13% | 0.68% | ETF | No |
| CIBR | First Trust NASDAQ Cybersecurity ETF | $7.22B | 20.9% | 0.50% | 0.59% | ETF | No |
| GRID | First Trust NASDAQ Clean Edge Smart Grid Infrastructure Index Fund | $2.05B | 14.8% | 0.90% | 0.56% | ETF | No |
| PAVE | Global X US Infrastructure Development ETF | $9.72B | 9.7% | 0.70% | 0.47% | ETF | No |
| BOTZ | Global X Robotics & Artificial Intelligence ETF | $2.65B | 9.6% | 0.30% | 0.68% | ETF | No |
| PHO | Invesco Water Resources ETF | $2.33B | 4.9% | 0.60% | 0.59% | ETF | No |
| GUNR | FlexShares Global Upstream Natural Resources Index Fund | $5.68B | 2.5% | 3.2% | 0.46% | ETF | No |
| LIT | Global X Lithium & Battery Tech ETF | $1.23B | -0.1% | 0.6% | 0.75% | ETF | No |
| URA | Global X Uranium ETF | $3.91B | -0.7% | 5.7% | 0.69% | ETF | No |
All in all, thematic investing can be a powerful way to score excess returns. And thanks to the growth of ETFs specializing in themes and trends, adding them to a model can be easy for advisors and investors. The key is identifying real trends with staying power and keeping the weighting to 10 to 20% of equity assets. This will allow investors to gain excess returns and keep volatility low.
Bottom Line
Thematic investing is a great way to add additional returns to a portfolio for the long haul. And thanks to the growth of ETFs, adding thematic investing to a model is simple. With a few tickers, investors can add long-term trends and potentially realize excess returns.
1 Goldman Sachs (July 2020). Thematic Investing: Portfolio Implications & Allocation Considerations
