In Focus: Megatrends  

How to manage risk in thematic ETFs

  • To understand what is driving the boom in thematic investing
  • To understand how to assess risk in thematic ETFs
  • To learn what to look for when picking a thematic ETF
How to manage risk in thematic ETFs
Understanding the risks of investment in thematic funds (Credit: Pixabay)

Assets in European thematic exchange-traded funds have more than quintupled to €35bn (£29bn) over the trailing three years.

A record 35 thematic ETFs launched in Europe in 2021, which means there are more thematic options listed than ever before, so it has never been more important that investors understand how these funds differ from one another and what the risks of investment are.

Thematic ETFs select stocks based on their exposure to one or more investment themes like robotics and automation, energy transition or cybersecurity.

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These funds attempt to tap into macroeconomic or structural trends that transcend the traditional business cycle. 

Why now?

The recent boom in thematic investing globally has been driven by several different developments.

Polarisation of growth means companies with exposure to certain, potentially world-changing, technologies have benefited from rapid growth and soaring stock prices.

These have offered investors outsized returns and this outperformance has still attracted more flows, as the chart below shows.

Assets in European thematic ETFs 2012-22 (Source: Morningstar)

This was particularly obvious over the initial stages of the global pandemic, when most thematic ETFs outperformed the broad market by a comfortable margin.

For example, the Wisdom Tree Cloud Computing ETF returned 109 per cent in 2020 while MSCI World returned 12 per cent. 

Some argue that fundamental changes in the way the global economy functions have supported the growth of thematic investing.

For example, some suggest that the 'metabolic rate' of the economy is accelerating, with industry dynamics evolving faster than ever and profit pools shifting across value chains in many industries.

Growing irrelevance of geographic and sector groupings in a globalised world means where a stock is listed can have very little bearing on where it sources its revenues. For example, London-listed BP derives a fraction of its revenue from the UK.

Equally, sprawling tech giants that operate in a kaleidoscope of emerging and existing industries are testing the traditional global industry classification sector frameworks like never before. 

Kenneth Lamont is senior research analyst at Morningstar





Steady improvements in the quality and granularity of financial data mean that highly targeted indices and investment strategies can now be constructed and maintained.

Mass customisation and increased access to financial markets is a topic less relevant in Europe, but the rise of low-fee or commission-free trading on platforms like Robinhood in the US and the rise of ETF investing has facilitated retail investment flows.

Retail investors have historically been attracted to thematic investments with strong narratives, which has contributed to the success of stocks and funds connected with themes.

A trifecta bet

One of the most important things investors mulling an allocation to these funds need to understand is that they are making a bet; to borrow an example from the racetrack, they are making a trifecta bet, or a three-way bet.