Thematic investing — how to invest in trends

There is a certain appeal to the idea of spotting the future and putting your money behind it. Not just buying shares in one company, but backing an entire direction of travel — clean energy, artificial intelligence, an ageing global population, the shift away from dependence on China. Thematic investing is built on exactly that instinct: instead of picking individual winners, you invest in the theme itself.

It sounds elegant, and in many cases it is. But thematic investing has a habit of looking obvious in hindsight and fiendishly difficult in practice. Understanding what it actually involves — and where it tends to go wrong — is the difference between a smart long-term allocation and buying into a story that has already peaked.

At its simplest, thematic investing means identifying a structural trend that you believe will shape the economy over the coming years or decades, then building a portfolio that benefits from that trend playing out. The key word is structural. A thematic investor is not trying to call the next quarter’s earnings — they are making a broader bet on how the world changes over time.

The most common way to do this today is through a thematic exchange-traded fund, or ETF. These are investment funds that track a basket of companies selected because they are exposed to a particular theme. You can now find ETFs covering everything from clean hydrogen to cybersecurity, from genomics to digital payments. Some are highly focused on a single subsector; others are broader, bringing together dozens of companies linked to a wider trend like the energy transition or the digitisation of finance.

The alternative is to build your own thematic portfolio by buying individual shares in companies you think are well placed to benefit. This gives you more control but requires considerably more research, and it concentrates the risk on a smaller number of bets. For most investors approaching thematic ideas for the first time, a thematic ETF is the more practical starting point.

Some of the themes attracting the most interest among UK investors right now include artificial intelligence and the infrastructure that supports it, the decarbonisation of energy and transport, defence and geopolitical resilience, healthcare innovation and the strains placed on it by ageing populations, and reshoring of manufacturing as global supply chains get reorganised. These are not short-term fads. They are driven by policy, demographics, technology, and capital allocation decisions that play out over a decade or more.

That long timeline is part of the appeal. But it is also a source of the biggest risk in thematic investing, which is timing. A theme can be entirely correct and still produce poor returns if you buy into it after the market has already priced in the good news. Clean energy ETFs, for instance, had a spectacular run through 2020, attracted huge inflows from investors convinced the energy transition was unstoppable, and then spent the following three years giving most of those gains back as interest rates rose and sentiment shifted. The theme has not gone away — the energy transition is still happening — but investors who bought at the peak in early 2021 had a difficult experience.

This is the trap that catches many people who approach investing through themes: by the time a trend becomes widely discussed, a significant amount of its expected value may already be reflected in the share prices of the companies involved. The best time to invest in a theme is often before it becomes a headline — which is, of course, also the most uncomfortable time to do it.

Thematic ETFs also tend to be more concentrated than a broad market fund, sometimes dramatically so. A fund themed around artificial intelligence might hold fifty companies, but if the top ten account for sixty per cent of the portfolio and several of those are the same mega-cap technology firms that appear in every other fund you own, then you are not getting as much diversification as the theme might suggest. It is worth reading the fund’s holdings before you commit, rather than just the marketing description on the tin.

Costs matter too. Thematic ETFs typically carry higher ongoing charges than plain index trackers, because assembling and maintaining a specialist index requires more active management. The difference between an annual charge of 0.07 per cent on a global tracker and 0.65 per cent on a thematic ETF might not sound significant, but compounded over ten or twenty years it becomes a meaningful drag on your returns. That drag needs to be justified by the performance of the theme itself.

Despite these caveats, thematic investing is not inherently reckless. Used sensibly, it can be a legitimate way to build exposure to parts of the economy that a standard index underweights. The FTSE 100, for example, is heavy on banks, miners, and oil majors. A UK investor who holds only the FTSE 100 has relatively little exposure to technology, healthcare innovation, or the energy transition. A small allocation to a carefully chosen thematic fund can round out a portfolio rather than concentrating it.

The key word there is small. Most financial planners who are comfortable with thematic investing treat it as a satellite allocation — something that sits around the edges of a core portfolio of diversified, low-cost index funds, rather than replacing that core. Putting ten or fifteen per cent of a portfolio into one or two thematic ideas is a very different proposition from going all-in on whatever the dominant narrative of the moment happens to be.

Picking between individual companies and a thematic ETF also comes down to how much time and conviction you have. If you genuinely believe that a specific company is best placed to capitalise on a trend, and you have done the research to support that view, then a direct shareholding gives you the full upside of being right. If you are confident in the direction of travel but uncertain which companies will come out on top, a fund that spreads the bet across the sector makes more sense. Both are valid approaches. The mistake is confusing confidence in the theme with confidence in any particular company.

One thing thematic investing does reliably well is focus the mind. It forces you to think about why you own what you own and what you expect to happen over a meaningful period of time. That discipline — understanding the thesis behind your investment and being able to articulate it — is useful regardless of how your portfolio is structured.

TL;DR — the short version

• Thematic investing means backing a long-term structural trend rather than picking individual companies.
• Thematic ETFs are the most practical entry point for most investors, spreading the bet across many companies exposed to a theme.
• The biggest risk is timing — a theme can be entirely correct yet produce poor returns if you buy after the story is already priced in.
• Thematic funds tend to be more concentrated and more expensive than plain index trackers, so always read the holdings and check the charges.
• Treat thematic investing as a satellite position around a core diversified portfolio, not a replacement for one.
• Confidence in a theme is not the same as confidence in any individual company within it.

Disclaimer: The value of investments can go down as well as up, and you may get back less than you invest. This article is for informational and educational purposes only and does not constitute financial advice. Always do your own research and consider seeking independent advice before making any investment decision.