In our previous article on ETFs (Exchange Traded Funds), we covered the merits of using them to diversify your investment portfolio. Now we’re taking a closer look at thematic investing - a selective, industry-specific approach to ETFs.
What is thematic investing?
Thematic investing involves selecting stocks within a particular industry, theme, or niche. It’s a strategic game, using research, industry knowledge, futures analysis, and predictive abilities to spot trends and megatrends.
It provides a much more targeted exposure than ‘broad-based indices’ such as the S&P 500 or the S&P/ASX 200.
What are megatrends?
Megatrends are social and economic phenomena that are based on a convergence of industries.
An example might be developments in global agriculture. Converging trends of hydroponic technology, vertical farming, and plant-based diets will inevitably point to certain products and their stock values performing well over the coming years. A thematic investor seeks to spot these convergences before they’ve been fully realised.
Investors who anticipated the rising popularity of electric cars when Tesla was still in its nascency - alongside the correlative need for more green energy - are likely already profiting from that foresight today.
Other examples of megatrends are AI and VR, climate change, and global population ageing.
Taking a long, wide, global view enables thematic investors to spot trends and developments that may not yet be priced into the market.
Why consider thematic investing?
Inventions of General Purpose Technologies (major developments like electricity, the computer, the internet) have occurred closer and closer together as history has progressed. Innovation is accelerating, leading to rapidly changing trends and year-on-year disruption, and drawing previously disparate industries closer together.
Hospitals, construction sites, and law firms would all have functioned in completely different ways 20 years ago. Now, they might use similar cloud software and communications technology. For example, hospital pagers, onsite walkie-talkies, and law office landline phones may all have been replaced with smartphones.
What all this means is that it’s becoming more and more likely for truly disruptive, innovative startups and organisations to generate large-scale profits due to their high customer stickiness and broad market reach.
Analysis of ‘flows’ - the movement of cash in and out of ETFs - is a metric that’s showing dramatically increased activity over the past year.
For example, flows into the ETFS Battery Tech and Lithium ETF (ASX: ACDC) totalled $47 million in 2020. Flows into the ETFS Global Robotics and Automation ETF (ASX: ROBO) in 2021 have already surpassed its total flows for 2020. And the VanEck Vectors Video Gaming & eSports ETF (ASX: ESPO) has already brought in $27 million of investment this year alone.
Pros and cons of thematic investing
Thematic investing is not a low-risk strategy. This is due in part to the high active share of thematic ETFs (the fraction of a fund's portfolio that differs from the benchmark index). But they may outperform broader benchmarks in a bull market. Higher risk, higher potential reward.
It’s also easy to find and invest in thematic ETFs on the ASX.
Selecting an ETF of this nature allows you to diversify across ‘horizontals’ - markets where the product is widely used, or present across a wide range of industries.