Thematic investing has generated significant interest across the investment community in recent years. In tandem, thematic index investing is increasingly making headlines as investors seek passive options that offer the same exposure as an active thematic approach but with lower fees.

The issuers of thematic ETFs identify the popular trends in the market and issue products that track these investment themes. However, empirical evidence shows that by the time new ETFs enter the market, the securities they invest in have already reached their valuation peak. In other words, investors in newly launched thematic ETFs are erroneously extrapolating past performance into future performance. In short, new Thematic ETFs are designed to appeal to (largely retail) investors’ irrational beliefs.

What is a theme?

A theme is a top-down, innovative or disruptive trend that has a structural tailwind with the potential to drive above average stock returns for companies participating in that theme. These themes are continuously evolving, and their returns cannot easily be explained by traditional country, sector or style factors. Examples of themes include fintech, the future of education, energy efficiency and automation.

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