ETFs & Funds · Intermediate · 4 min

Thematic ETFs: opportunities and traps

You can explain what a thematic ETF holds, why it is concentrated and often more expensive, and which questions to ask before buying one.

Invest in a story

Robots, clean energy, space travel, artificial intelligence, video games. For almost every trend, there is an ETF that promises to let you invest in it with one click.

Thematic ETFs are easy to understand and exciting to own. That is exactly what makes them tricky. A good story is not the same as a good investment, and the way these funds are built adds risks that broad funds do not have.

Concentrated and late

A thematic ETF holds companies selected because they are linked to a particular trend. Its index provider defines which companies count, for example by the share of revenue they earn from the theme.

Compared with a broad index fund, a thematic fund usually is:

Concentrated: it holds fewer companies, often from one or two industries. A setback for the theme can hit most of the fund at once.
More expensive: fees are often higher than for funds on broad indices.
More volatile: themes attract enthusiasm in good times and lose it quickly in bad ones.

There is also a timing problem.

New theme funds are often launched when a story is already popular and the related shares have already risen. That is when investors are most interested. But as you saw in the lesson on news, markets trade expectations. If the growth everyone talks about is already in the price, even a trend that comes true can disappoint investors.

The SEC has warned investors about hype around popular themes such as artificial intelligence, where excitement can run ahead of facts.

Finally, check the holdings. Some thematic funds hold many of the same large companies that already dominate broad indices, at a higher fee.

Right trend, wrong price

A fictional theme becomes the talk of the market. Related shares double within a year. A new ETF on the theme launches and attracts large inflows.

Over the next two years, the trend continues: the companies grow their sales.
But growth is slower than the hype implied. Prices fall back.
The fund ends two years after launch 40% below its starting price.

The investors were right about the trend and still lost money, because they paid a price that assumed even more.

Common mistakes

Buying the theme everyone is talking about. The excitement is often already priced in.
Judging the fund by its name. Check what it actually holds.
Putting a large share of savings into one theme. It is a concentrated bet.
Ignoring fees. Thematic funds often cost several times more than broad ones.

The takeaway

Thematic ETFs bet on a story, such as robots or clean energy. They are concentrated, often pricey, and often launched after the story is priced in.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the step at which many investors first discover a theme.

Tap the chart.

Funds are often launched once a theme is already popular, after much of the price rise has happened.
2Why is a thematic ETF usually riskier than a broad index fund?

A narrow focus means one setback can hit most of the fund at once.
3A theme like electric cars grows fast. Does that mean the shares will do well?

As in the lesson on news, markets trade expectations. A good story can be fully priced in.
4What should you check first in a thematic ETF?

The name sells the story. The holdings show whether the fund actually fits it, and costs are often higher than for broad funds.

of 4 correct.