Investors are increasingly attracted to the potential of thematic Exchange Traded Funds (ETFs), which promise growth and innovation through focused investments in rapidly advancing sectors.
According to Prof. Dr. Rolf Tilmes, CFP, who is the head of FPSB Deutschland and teaches at EBS Executive School, thematic ETFs offer the opportunity to capitalize on trends by targeting leading companies within specific sectors. One area of growing interest is artificial intelligence, with Statista reporting the global market volume for AI at approximately $208 billion for 2023, predicted to soar to over $1.8 trillion by 2030.
The concept behind thematic ETFs is simple: channel investment funds toward sectors poised for growth, ideally enabling investors to outperform the broader market. Currently, investors can find ETFs focused on various themes, from electric mobility and renewable energy to hydrogen technology and even the pet care industry.
The surging popularity of ETFs stems from their attractive features. These funds typically come with lower costs and greater transparency than traditional actively managed funds, which has contributed to their rising acceptance among both institutional and individual investors. Notably, analysts at ETFGI reported net inflows of $1.45 trillion worldwide through the first ten months of 2024, outpacing previous records from as far back as 2021.
"ETFs are becoming more popular due to their low cost and flexibility," stated Prof. Dr. Tilmes, highlighting how they allow investors to easily diversify their portfolios beyond standard indices like the MSCI World or FTSE Global. This dynamic presents unique investment opportunities but is not without its own set of risks.
One key concern is the narrow focus of thematic ETFs, which can expose investors to heightened volatility due to the limited number of companies underlying a specific theme. When the universe of investable companies is small, individual stock price movements can pack significant consequences for fund performance. What’s more, many thematic ETFs launch after much of the underlying theme’s growth has already been realized, which could hinder projected future performance.
"There’s no guarantee the drivers of sustainable growth will remain applicable; regulatory constraints or reductions in fiscal support for specific sectors can easily alter dynamics significantly," Prof. Tilmes cautions. He emphasizes the need to differentiate between genuine structural changes and short-lived trends when considering investments.
Past experiences have shown notable volatility within thematic ETF sectors, with 2024 even seeing capital outflows from certain thematic funds. Evidence suggests these concentrated investments tend to lag behind broader market indices, reinforcing the caution necessary when considering these financial products.
Choosing the right ETF becomes challenging, as many thematic products track proprietary indices with different stock selection criteria, leading to significant variances even among ETFs covering the same theme. Therefore, investors need to be diligent and thorough when selecting thematic ETFs to understand the underlying criteria used for inclusion and the market dynamics of the specific sector.
For long-term wealth-building, diversified investments across indices remain fundamental. Yet, thematic ETFs can complement core investments as satellite holdings, allowing investors to tailor their portfolios to individual objectives and risk appetites, provided they are approached realistically and knowledgeably. Prof. Dr. Rolf Tilmes advises, "Using thematic ETFs should be seen as small additions to one's portfolio after thoroughly researching the underlying trends and performing careful selection of the funds."