Investment Primer: The Thematic Composite

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What, Why, and How of Thematic Funds

The Thematic composite includes funds that go beyond traditional sector and industry classifications to provide exposure to long-term structural shifts, nuanced areas of the market, or specific investment outcomes. The “why” is to invest in high-conviction ideas that are reshaping the economy, technology, or society. Unlike a sector fund, which is defined by what a company does (e.g., makes software), a thematic fund is defined by what a company is exposed to (e.g., benefits from the rise of artificial intelligence).

This creates a crucial nuance. Thematic funds are different from sector funds in three key ways:

  1. They often focus on new, evolving markets that don’t fit neatly into a single sector, such as disruptive technology or the next industrial revolution.
  2. They are frequently cross-sector. An “Infrastructure” theme might include companies from the Industrial, Utility, and Materials sectors.
  3. They can be very niche, targeting specific concepts like gold miners or seeking a particular outcome, such as the high income potential offered by MLPs.

The “how” is achieved through both passive and active management. Many thematic funds are passive Beta strategies that track specialized, often proprietary, indexes. However, there is a growing number of actively managed Tactical funds where a portfolio manager selects companies they believe are best positioned to capitalize on a theme. These funds can be used for long-term strategic plays on a developing trend or for more tactical positions to capitalize on a near-term catalyst.

Portfolio Construction Approaches

Due to their concentrated and often volatile nature, thematic funds are almost always used as “satellite” positions to complement a core U.S. or global equity holding.

  • Strategic Overweighting (Thematic Tilting): An investor might use a broad market fund as their core but believe that a specific theme, like cybersecurity or clean energy, has superior long-term growth prospects. They can add a dedicated thematic ETF to their portfolio to express this high-conviction view. This is a long-term, strategic bet on the outperformance of that specific theme.
  • Tactical Positioning: While most themes are long-term, some can be used tactically. For example, an investor might buy a Natural Resources or Infrastructure ETF if they believe government spending or inflation will provide a near-term catalyst. This position would be held until the investment thesis plays out.

A Practical Guide to Locating Funds in the ETF Action Database

A proper peer group is essential for any comparative analysis. A good starting point is the Thematic ETF Dashboard, which groups all relevant ETFs by their specific theme, with hyperlinks to the ETF Database for deeper analysis.

Foundational Screening: Building the Initial Universe

The first step is to use the top-level classification filters to isolate funds within the Thematic composite.

  • Step 1: Select the Database. Navigate to the ETF, Mutual Fund, or other desired database.
  • Step 2: Filter by Asset Class. Select Asset Class = Equity.
  • Step 3: Filter by Composite. Select Composite = Thematic.
  • Step 4: Filter by Category. To find funds for a specific theme, select the desired Category (e.g., Disruptive Technology, Health Care Innovation, Infrastructure, Sustainability).

Advanced Filtering: Refining Your Peer Group

After the foundational screen, the list can be refined by screening for outliers and unique characteristics.

  • Brand (Issuer): Investors may prefer to stick with established fund providers with long track records in thematic investing.
  • Assets Under Management (AUM): Setting a minimum AUM threshold can screen out smaller, less liquid funds.
  • Expense Ratio: Thematic funds often have higher fees, so screening by expense ratio is important.
  • Liquidity (ETFs only): For ETFs, metrics like average daily trading volume and bid-ask spreads are particularly important for tactical trading.

Section 4: A Framework for Evaluating Thematic Funds

A thorough evaluation of thematic funds is critical because two funds with a similar name can be vastly different “under the hood.” A “Robotics” ETF from one issuer might be full of U.S. software companies, while another might hold Japanese industrial manufacturers. This makes a deep, quantitative look-through analysis and a qualitative review of the fund’s methodology absolutely essential.

Risk/Return Analysis: The Importance of Benchmarks

The foundational step is to analyze a fund’s historical risk and return profile. Because thematic funds don’t have a universally accepted benchmark, their performance is often compared against a broad market index to understand their risk and potential for alpha.

ETF Action assigns a Beta Tracker to each category—typically a broad-based ETF like the S&P 500 or Nasdaq 100. Key metrics from the Risk & Return report should be compared against this Beta Tracker to gauge performance. While the examples below are some of the most common, ETF Action’s comprehensive datasets provide a full suite of risk statistics for deeper insights.

  • Total Return: How has the fund performed over various time periods compared to the broad market?
  • Standard Deviation (Volatility): Was the fund more or less volatile than the broad market? Thematic funds are often more volatile.
  • Sharpe Ratio: Did the fund provide better risk-adjusted returns?
  • Alpha: Did the fund add value beyond what would be expected based on its market risk?

Quantitative Analysis: The Power of Look-Through Analytics

A fund’s name tells you its theme, but its holdings reveal its actual exposures. Look-through analysis is the only way to understand the “why” behind a fund’s performance and to compare two seemingly similar thematic funds.

  • Sector, Industry & Geographic Exposure: This is the most important look-through analysis. Is a “FinTech” fund invested in U.S. software companies or global payment processors? Is a “Clean Energy” fund focused on U.S. utilities or Chinese solar panel manufacturers? These exposures are the primary drivers of risk and return.
  • Concentration: Thematic funds are often highly concentrated. Look-through data reveals if the fund is dominated by a few mega-cap stocks or diversified across many smaller, more speculative companies.
  • Fundamental Characteristics: Look-through analysis of fundamental data is key to verifying a theme’s profile. An analyst can use valuation multiples (like P/E and P/B ratios) and growth metrics (like earnings and sales growth) to confirm that a “Disruptive Technology” fund is truly invested in high-growth companies, or that an “Infrastructure” fund holds stable, dividend-paying firms.

While a detailed, manual look-through analysis provides the deepest insights, it can be time-intensive. ETF Action’s derived analytics are designed to simplify this process by providing a completely objective, rules-based framework. For funds in this composite, the Equity – Sector Assignment will often be “Concentrated” or “Sector Specific,” confirming their focused nature. The real value comes from the other derived analytics, particularly the factor scores. These scores quantify the intensity of a fund’s characteristics—such as its Value, Growth, Quality, or Yield tilt—on a numeric scale relative to a broad market benchmark. This allows an analyst to objectively verify if a “Disruptive Tech” fund has a high Growth score or if a “Natural Resources” fund has a high Value score, providing a powerful framework to more efficiently compare funds and conduct an initial evaluation.

Qualitative Analysis: Evaluating the Strategy

For thematic funds, the qualitative analysis is all about understanding the process for selecting companies that fit the theme.

  • For Passive Funds (Beta): The key is to understand the index methodology. How does the index provider define the theme? What are the specific, rules-based criteria for including a company in the index? Is it based on revenue streams (e.g., >50% of revenue from a specific activity), patent filings, or the analysis of an expert committee? The prospectus is the only place to find this information, and it is essential for understanding what you are actually buying. Two “AI” funds might have completely different definitions of what constitutes an AI company, leading to very different portfolios.
  • For Active Funds (Tactical): The focus is on the manager’s process. How do they define the theme, and how does that differ from passive alternatives? What is their process for identifying and selecting companies that fit the theme, and what are their criteria for selling a position? The qualitative review should confirm that the manager’s philosophy is repeatable, consistent, and actually reflected in the portfolio’s look-through characteristics.

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