As such, if the theme itself evolves and takes a different shape then the index may not reflect this change. Themes are often dynamic by their nature, and an issue with the traditional sector approach is that sector classifications often lag behind market trends – in other words, the sector approach is trend agnostic.
Innovation
Recently there has been innovation in the construction of thematic indices in order to address these issues.
One concept, for example, has been developed by Nasdaq’s index business in conjunction with San Francisco-based AI start-up Yewno – with input from DWS Xtrackers. They have created indices that combine the traditional sector screening approach with a filtering system designed to harness those companies likely to see future thematic success thanks to patents they own or that are linked to them.
The methodology itself uses Yewno’s proprietary AI-based patent screening system to analyse over three million approved patents from the US International Patents Office and the World Intellectual Property Organisation.
The patents date back to 2007, with coverage of more than 1,200 stocks from both developed and emerging markets. Yewno processes the patents, linking them to the stocks that own them, as well as, with the use of key word filtering, assigning patents to themes they are relevant to.
The data produced is then used by Yewno to assign two scores to every stock in their coverage – a ‘pure score’, and a ‘contribution score’.
The pure score represents the ‘pure play’ nature of the stock to a theme (percentage of patents from that theme compared with overall patents the company holds). It is crucial that thematic investments allocate to stocks that are likely to witness material increases in their share price if that specific theme grows.
This screen is therefore designed to filter out stocks that may have some exposure to a theme, but where the theme is not core to their business model, which means it is not driving the performance of their shares.
Secondly, Yewno also establishes a contribution score (the percentgae of patents the company holds in that theme compared to the percentage of patents in the total theme).
This screen acts as a hedge to the first screen. Some ultra large-cap companies hold tens of thousands of patents, and so their pure score may be diluted by the volume of total patents, but if one of these stocks owns a large percentage of patents in a specific theme then their inclusion is important to fully represent that theme.
Targeting themes
Nasdaq then brings the two scores together, and combines these with a more traditional industry constituency screen to ultimately produce the final thematic index.
