What Is a Thematic ETF?

Thematic ETFs focus on a specific theme or industry, rather than tracking a broad market index like the S&P 500 or Dow Jones Industrial Average. Learn how thematic ETFs work, their benefits and risks, as well as how to choose the right types to suit your investment goals and tolerance for risk. 

What Is a Thematic ETF? 

A thematic ETF is an exchange-traded fund that invests in a specific theme or trend. For example, a thematic ETF might focus on companies involved in renewable energy, cloud computing or artificial intelligence. Thematic ETFs can also focus on broader themes such as sustainability, demographics or innovation. 

Thematic ETFs are like traditional ETFs in that they are a basket of stocks or other assets, but their focus is narrower and more specific. Rather than investing in a broad market index like the S&P 500, thematic ETFs invest in companies that align with the chosen theme. 

Benefits and Risks of Thematic ETFs 

Thematic ETFs offer investors multiple benefits, including exposure to growing industries. However, these unique funds present risks, such as volatility, that investors should carefully consider before buying shares.  

Benefits of Thematic ETFs 

• Exposure to growing industries: Thematic ETFs allow investors to capitalize on growing trends and industries, such as electric vehicles, which can potentially lead to higher returns.  
• Diversification: Thematic ETFs can provide investors with diversification within a particular industry or theme, allowing them to invest in a basket of stocks rather than individual securities. 
• Accessibility: Thematic ETFs provide exposure to a basket of securities with a specific theme, enabling investors to access a broad range of securities in one fund without needing access to private markets. 

Risks of Thematic ETFs 

• Concentration: Thematic ETFs invest in a niche theme or industry, which can result in concentration risk. If the industry experiences a downturn, the ETF's value can suffer. 
• Volatility: Thematic ETFs can be more volatile than broad-based ETFs due to the concentrated nature of their holdings. This can result in larger fluctuations in the ETF's price. 
• Limited diversification: While thematic ETFs can provide diversification within a particular industry or theme, they may not provide the same level of diversification as a broad-based ETF. 
• Limited track record: Some thematic ETFs may have limited track records, making it difficult for investors to evaluate their long-term performance. 

Types of Thematic ETFs 

There are many different types of thematic ETFs available that offer investors exposure to specific themes or industries, providing a way to diversify their portfolios and potentially capture returns from emerging trends. Here are some types of thematic ETFs: 

• Industry-specific sector ETFs: These ETFs focus on a particular industry or sector, such as biotechnology, clean energy, renewable energy or financial technology. 
• Mega-trend ETFs: These ETFs focus on long-term societal or economic trends, such as automation, artificial intelligence or the growth of emerging markets. 
• ESG ETFs: These ETFs focus on environmental, social and governance (ESG) criteria, such as companies with sustainable business practices or those with a positive impact on society. 
• Smart beta ETFs: These ETFs use alternative weighting strategies to traditional market-cap-weighted ETFs, such as weighting based on volatility or dividend yield. 
• Factor-based ETFs: These ETFs focus on specific factors, such as value, growth or momentum, to capture market trends and generate returns. 

Examples of Thematic ETFs 

There are many thematic ETFs available in the market that focus on various themes or industries. Here are a few examples of thematic ETFs: 

• Invesco Solar ETF (TAN): This ETF invests in companies involved in the solar energy industry. 
• ARK Innovation ETF (ARKK): This ETF invests in companies that are expected to benefit from disruptive innovation in various sectors, including technology, health care and financial services. 
• Global X Lithium & Battery Tech ETF (LIT): This ETF invests in companies involved in the lithium mining industry and the production of battery technology. 
• iShares Cybersecurity and Tech ETF (IHAK): This ETF invests in companies involved in the cybersecurity and technology industries. 
• VanEck Semiconductor ETF (SMH): This ETF invests in companies involved in the semiconductor industry, including manufacturers of microprocessors, memory chips and other semiconductor components. 
• First Trust Cloud Computing ETF (SKYY): This ETF invests in companies involved in the cloud computing industry, including cloud software and infrastructure providers. 

These are just a few examples, but there are many other thematic ETFs available that focus on different themes and industries, such as health care, biotechnology, artificial intelligence and more. 

How to Choose the Right Thematic ETF 

With so many options available, it can be challenging for an investor to choose the right thematic ETF for their investment goals. The process of finding the best thematic ETFs to suit a particular need in a portfolio is like the process of choosing the best ETFs for a portfolio in general. 

Here are some steps for choosing the right thematic ETF: 

• Understand the theme: Thematic ETFs are based on specific themes or industries, so it's essential to understand the underlying theme of the ETF you are considering. This will help determine whether the ETF aligns with an investor’s goals and risk tolerance. For example, if an investor believes renewable energy is a growth industry, they might consider a renewable energy-themed ETF. 
• Evaluate the ETF's holdings: Thematic ETFs hold a basket of stocks that fit the theme or industry they are focused on. Investors should look at the ETF's holdings to make sure they align with the intended thematic strategy. It's also important for investors to evaluate the concentration of holdings to determine if the ETF is diversified enough to suit their needs. 
• Consider the expense ratio: Expense ratios can vary widely among ETFs, so it's essential to evaluate the expense ratio of any ETF you are considering. Lower expense ratios generally result in higher returns, so it's essential to choose an ETF with a low expense ratio to maximize long-term returns. 
• Evaluate the ETF's performance: Past performance is not an indicator of future returns, but evaluating an ETF's historical performance can provide insight into how the ETF may perform in the future. Look at the ETF's returns over different time frames and compare them to its benchmark index to determine how well it has performed. 
• Assess the ETF provider: The ETF provider's reputation and track record are important considerations when choosing a thematic ETF. Look for providers with a long track record of successfully managing ETFs and a good reputation in the industry. 
• Understand the risks: As with any investment, there are risks associated with thematic ETFs. Be sure to understand the risks associated with the theme or industry the ETF is focused on and evaluate the ETF's historical performance during different market conditions. 

Bottom Line 

Thematic ETFs offer exposure to niche markets within a specific industry or theme that can have greater growth potential than a broad-market ETF. However, investors should understand all the benefits and risks of thematic ETFs, as well as their investment goals and risk tolerance, before investing.