Thematic Investing: Is Betting on Big Ideas a Smart Move?
- Daniel Kurt
- Jan 20
- 5 min read
Updated: 2 days ago
Main takeaways
Thematic investing focuses on big-picture trends like AI and clean energy to drive your investment decisions.
You can invest thematically in several ways, from hand-picking stocks to buying specialized ETFs or using robo-advisor portfolios that target specific sectors.
A thematic approach offers growth potential and diversification, but it also comes with higher costs, more research demands and greater risk.
Smart thematic investors diversify across multiple trends and avoid putting too much money into any one theme or company.
The growth of artificial intelligence. The aging of the global population. The push to combat carbon emission with clean energy.
All these trends have the potential to shape the worldwide economy in the decades ahead. Thematic investing is a way to harness these broad undercurrents with the hope of achieving above-average returns for your portfolio.
We’ll delve into what thematic investing is and whether this novel strategy lives up to its promise.
What is thematic investing?
Thematic investing involves identifying broad trends, or “themes,” that are likely to drive long-term profitability and determining which companies are most likely to capitalize on those underlying factors. By riding these big economic waves, rather than swimming against the tide, the investor is hoping to beat the broader stock market over the long haul.
Say, for instance, that you’re convinced that innovations like precision medicine and genomics represent the future of healthcare. You may find that there are a number of companies—some with seemingly little in common—that stand to benefit from such developments.
Consequently, you might devote a part of your investment portfolio to biotech companies that are designing cutting-edge medicines or finding new ways to repair genetic defects by editing DNA. In addition, you might find businesses that stand to benefit in more indirect ways, like those specializing in bioinformatics (evaluating enormous amounts of data to guide biotech companies) or the production of lab equipment.
Ways to incorporate thematic investing into your portfolio
So you’re sold on the concept of using macro-economic trends to generate returns. How do you actually go about thematic investing? There are any number of ways to use this strategy, but here are some of the most common ones:
Hand-picking stocks
This is the do-it-yourself method, where you identify the specific megatrends that you think are most compelling and select individual companies that could stand to benefit the most. The advantage: you’re in total control of which investments you choose.
But selecting your own stocks has its downsides, too. You have to become an expert in the theme you’re using to guide your strategy. And you have to research how individual companies could potentially be impacted by that trend.
Thematic funds
A number of major financial firms have launched mutual funds or exchange-traded funds (ETFs) that focus on specific macro-economic trends. Fidelity, iShares and Blackrock, for example, have their own theme-focused products.
Investing through a fund certainly makes it easier to tether your portfolio to a specific current in the economy, since the fund company is choosing the underlying securities for you. Typically, they use either the expertise of a fund manager or artificial intelligence to pinpoint compelling themes and identify companies that could stand to benefit from them.
You’ll want to watch the fees closely, though. The expense ratio for thematic funds runs around 0.40% on the low end, but can be 1.0% or higher for some companies. You may also have to pay an upfront fee for some offerings (Blackrock charges a 5.0% sales fee for certain thematic funds). So you’re counting on above-average returns to make up for those higher costs.
Customized robo-advisor portfolios
Platforms like Betterment or Wealthfront offer a limited number of specialized portfolios that may appeal to investors seeking to benefit from certain economic trends. For example, Betterment offers Climate Impact and Innovative Technology portfolios that direct assets to funds connected to those sectors of the economy.
These can be a compelling solution for those already investing through a robo-adviser. But the themes generally aren’t as numerous, nor as targeted, as the thematic funds offered by traditional brokerage houses. Indeed, a substantial part of the Innovative Technology fund is allocated to a broad U.S. stock market ETF with no specific focus on tech firms.
Most robo-advisors charge a fee based on the amount you invest, with access to a financial advisor generally costing more.
The pros and cons of thematic investing
While chasing emergent trends can be exciting, it's not without risks. Here are the biggest pros and cons of thematic investing you’ll want to be aware of before getting involved in thematic investing.
Pros
Growth potential. If you tap into a trend at the right time and use the right strategy, your dollars have the potential to outpace the broader market over time.
Diversification. Theme-based funds spread your money across multiple companies connected to a specific trend, so there’s less risk than betting on one specific stock.
Motivation. You may find that you’re more excited about investing when you’re forced to think about your holdings rather than choosing passive investments.
Cons
Risk. There are no sure things in the investment world. There’s a chance that the investments tied to a specific theme will underperform the stock market as a whole.
Time commitment. A DIY approach to thematic investing requires that you do your research about not only the trend that you’re following, but the specific stocks that you choose to buy.
Cost. Thematic ETFs often have higher expense ratios than index funds. Those larger fees can drag down your return unless the funds generate above-average returns.
Smart strategies for thematic investing
Chasing big trends without a plan can do more harm than good to your financial situation. If you want to ride a major wave in the market while protecting your money, here’s how to do it the smart way:
Diversify.
Choosing a small number of stocks is inherently riskier than spreading your money over a larger selection of investments. The more trends you invest in, and the more stocks that you buy based on that trend, the more stable your portfolio will generally be.
Become an expert in your trend.
Researching economic trends helps you spot which themes are actually gaining real-world traction versus just hype. Doing your homework also gives you a better chance of recognizing when a movement is accelerating or losing steam. But you can’t be an expert in everything—pick a relatively small number of themes that you really know something about.
Don’t follow the headlines.
The goal of thematic investing is to get ahead of emerging trends, not to follow along after the fact. If you’re regularly making investment decisions because of the latest news, it can backfire. If you choose to buy a stock after the company reports better-than-expected earnings, for example, you’ll likely have to pay more per share. Instead, use a forward-looking approach to your holdings.
Avoid going all-in.
Theme-based investments carry more potential rewards, but also more risks, than a more passive, “buy the market” approach. So if you go all in on one or two themes and strike out, it can be devastating for your financial health. Rather, designate a modest slice of your portfolio to thematic investments and use a more traditional strategy for the rest. For example, you might allocate 10% of your portfolio to each of three different themes, and use index funds or passive ETFs for the remainder.
The upshot
Hitching your portfolio to broad economic trends can add an exciting dimension to your investment strategy. However, choosing individual stocks always has inherent risks. If you buy securities based on themes, be sure to do your homework and make sure to diversify your assets.
