Thematic Investing

Thematic investing is an investment strategy that builds a portfolio around a long-term trend rather than around a country, sector or company size. Common themes include clean energy, electric vehicles, cybersecurity, artificial intelligence, robotics, healthcare for ageing populations, water and digital payments. The manager looks for companies whose revenues are expected to grow because of the trend, wherever they sit in the standard industry classification.

Thematic products are offered mainly as exchange-traded funds and equity funds, often tracking a custom index. In sustainable finance, "sustainability-themed investing" is one of the strategies listed by industry bodies, alongside exclusionary screening, best-in-class selection and impact investing. Not every theme is about sustainability, though: many are simply growth stories.

Think of someone who notices that more and more neighbours are installing solar panels. Instead of buying shares in one panel maker, they want a slice of everything around that trend: the firms that make the panels, the batteries, the cables, the installers and the software that runs the grid. That bundle is a theme.

A normal fund is organised like a supermarket by aisle: all the banks together, all the drug makers together. A thematic fund is organised like a recipe. It pulls one item from many aisles because together they make the dish. The bet is that the trend will keep growing for years and the companies tied to it will grow with it.

Building a theme portfolio usually follows a sequence:

1. Define the theme and its sub-themes, for example "energy transition" split into generation, storage, grids and efficiency.
2. Find companies exposed to it, using revenue data, patent filings or text analysis of company reports.
3. Set a purity test, such as a minimum share of revenue from theme activities.
4. Weight the holdings, often equally or with caps, rather than by market capitalization.
5. Rebalance and review the list as the theme and its companies change.

Because purity tests favour specialists, theme funds often hold many younger, smaller companies and fast-growing growth stocks. That links thematic funds closely to growth investing and to high valuations relative to earnings.

Many sustainability themes map to the UN Sustainable Development Goals or to the climate aims of the Paris Agreement: renewable power, energy efficiency, sustainable food, clean water, circular economy and social themes such as affordable housing and education. On the bond side, the same idea appears as use-of-proceeds instruments such as green bonds and social bonds. Thematic funds differ from a positive tilt, which stays close to the market, because they deliberately depart from it. They also differ from impact investing, which requires measurable outcomes and is often done in private markets; a listed theme fund buys existing shares and does not by itself fund new projects.

• Concentration. A theme fund holds a narrow slice of the market, so it lacks the diversification of a broad index and its volatility is usually higher.
• Timing. Themes often become popular after strong gains, so new money tends to arrive near peaks. Clean-energy shares, for example, rose sharply in 2020 and then fell heavily in the following years. This makes thematic investing vulnerable to market timing errors.
• The right trend, the wrong winners. A trend can play out exactly as expected while competition drives down profits, or the gains go to large companies outside the fund.
• Cost and churn. Thematic funds typically charge a higher expense ratio than broad index funds and may have a higher portfolio turnover ratio.
• Closures. Research by fund analysts such as Morningstar has found that a large share of thematic funds launched are later closed or merged, often after poor performance.

For these reasons many advisers treat theme funds as a small satellite holding around a diversified core, sized to the investor's risk tolerance and time horizon, within an overall asset allocation.

A theme in a fund's name brings rules on what the fund must hold. In the United States, the SEC's 2023 amendments to the fund Names Rule extended the 80% investment policy requirement to names that suggest a focus on particular characteristics, which covers many thematic and ESG names; compliance dates fall in June 2026 for larger fund groups and December 2026 for smaller ones. In the EU, ESMA fund-name guidelines apply thresholds and exclusions to sustainability-related terms. Investors should check a fund's prospectus for how it defines the theme and its purity test, and compare its returns against a relevant benchmark.

• Investor.gov (US Securities and Exchange Commission)
• European Securities and Markets Authority (ESMA)