Looking to invest in sectors like AI, clean energy, or cybersecurity through thematic ETFs? Before diving in, it’s important to undertake thorough research. This guide breaks down the essential steps – from understanding the theme to assessing risks and fees – to help you make more informed investment decisions with confidence.

Thematic ETFs have become a popular way for investors to get in on emerging trends and future-facing industries. Unlike traditional index funds that track the broader market, thematic ETFs focus on specific sectors, industries, or trends – like clean energy, artificial intelligence (AI) , or cybersecurity.

As exciting as it might sound to invest in the “next big thing,” it’s important to remember that with high potential comes higher risk. That's why thoroughly researching thematic ETFs is critical before jumping in.

Know the theme inside and out

The key characteristic of a thematic ETF is its laser focus on a particular idea or trend. It could be clean energy, blockchain technology , the rise of AI, or even demographic shifts like an ageing population. These funds aim to capture growth by investing in companies expected to benefit from the chosen theme.

Why theme research is crucial

Before investing in a thematic ETF, it’s essential to understand the long-term potential of the theme. Is this theme a passing trend, or does it have staying power?

Ask yourself:

• Is this a fleeting trend or a fundamental shift in how industries operate?
• What are the driving forces behind the theme's growth?
• Are there any significant risks (e.g., regulatory challenges or tech disruption) that could slow the theme's progress?

Examples of recently emerged themes

• Clean energy : Investing in companies driving the global shift toward renewable energy sources
• AI and robotics : Backing companies developing artificial intelligence and automation technologies
• Cybersecurity : Supporting businesses that provide solutions to fight cyber threats

Dig into the ETF’s portfolio

Once you’ve analysed the theme, it’s time to see how the ETF is built. The companies inside a thematic ETF are what drive its performance, so you need to know what you’re buying into.

Here’s what to focus on when evaluating holdings:

• Sector concentration: Some thematic ETFs may be heavily weighted in one sector. For example, an AI-themed ETF might have a high concentration in tech companies, making it more vulnerable to sector-specific downturns. While some funds spread their investments across sectors (e.g., clean energy ETFs ), others may be more focused
• Geographic exposure: Look at where the companies in the ETF are based. If an ETF is heavily concentrated in a single region, it can be more susceptible to economic changes in that area. A broader geographic spread could provide some protection against regional risks
• Company selection: Check the companies the ETF is investing in. Are they industry leaders; smaller, riskier companies; or a mix of both?
• Avoid portfolio overlap: If you’re already invested in other ETFs, check for portfolio overlaps . If your portfolio is too heavily weighted in one sector or theme, you might end up with unintended risks or missed diversification opportunities

Keep an eye on costs and fees

Thematic ETFs are often more expensive than broad-market ETFs, with higher expense ratios and other hidden costs. These fees might seem small, but over time, they can chip away at your returns.

The key costs to watch are:

• Expense ratio: This annual fee can range from 0.50% to 1.00% or higher for thematic ETFs. Compare this to traditional index funds, which often have expense ratios as low as 0.10%. Over the long term, these small differences add up, so it’s important to factor this in when evaluating your options
• Other fees: Don’t overlook the trading costs and bid-ask spreads (the difference between the buying and selling price of the ETF). The less liquid the ETF, the wider the spread, which can increase your costs

Even a slight difference in fees can make a big impact on your investment’s overall performance over time. Always consider the cost-benefit trade-off when assessing whether a thematic ETF is worth the extra expense.

Understand the risks involved

While thematic ETFs can offer significant upside potential, they come with their share of risks. It’s crucial to understand these risks and decide whether they fit with your overall investing strategy .

Some of the specific risks to consider include:

• Higher volatility: Because thematic ETFs focus on a narrow set of industries or sectors, they tend to experience higher volatility. For example, a clean energy ETF could see sharp price fluctuations depending on policy changes or technological advancements
• Lack of diversification: As mentioned earlier, unlike broad-market index funds that spread investments across many sectors, thematic ETFs are often more concentrated. This can increase the risk of underperformance if the chosen theme doesn’t take off as expected
• Speculative trends: Some themes, while exciting, are still speculative. AI and blockchain are good examples of this. Although the potential growth is undeniable, these technologies are still evolving, and some of the companies developing them might not be profitable for years

When comparing thematic ETFs to broader index funds, remember that broad funds generally offer lower risk. However, they may not capture the same high returns that come with a well-timed thematic play.

Look at performance, but don’t stop there

It’s tempting to pick a thematic ETF based on its past performance. But keep in mind that historical returns are not a guarantee of future success. Many thematic ETFs are relatively new and have limited performance history, making it difficult to draw conclusions solely based on past results.

You should consider:

• Historical performance: Look at how the ETF has performed compared to a relevant benchmark or other similar thematic ETFs. Are the returns driven by overall market trends, or is the theme truly driving growth?
• Backtesting: Some ETFs provide backtested data, showing how the fund would have performed during different market conditions. While this data isn’t foolproof, it can offer insights into how the theme might hypothetically perform under certain conditions
• Consider market cycles: Think about how the theme could perform during various market conditions. For example, a clean energy ETF might perform well during periods of growth but could struggle during economic downturns when energy consumption decreases

The bottom line: Doing your homework pays off

Investing in thematic ETFs can be a solid way to tap into high-growth industries and trends, but they come with unique risks. By thoroughly researching the theme, digging into the ETF’s portfolio, considering costs, and understanding the risks, you’ll be in a much stronger position to make informed investment decisions.

Thematic ETFs can certainly be a rewarding part of your portfolio, but like all investments, they require careful consideration. Take the time to fully understand the fund before committing, and ensure it aligns with your long-term financial goals and risk tolerance .

And if you’re ever in doubt, reach out to a licensed financial adviser for guidance.

Happy investing!