Fundamentals |

Thematic Investing: More Than a Story

Thematic ETFs allow investors to target specific trends and concepts while still providing a level of diversification.

The rise of high-frequency trading and quantitative strategies has made it difficult for the average investor to beat the pros simply by doing their own due diligence. If the common man or woman has an edge, it often stems from recognizing a new trend or product and getting in on the opportunity before the momentum swing occurs.

Spotting trends in the marketplace is part of what investing is all about. But two major problems can arise when investors take this type of simplistic approach to investment decisions.

(1) it completely ignores valuation, capital structure and other idiosyncratic risks

(2) it naturally skews toward consumer product companies

The second problem can be partially allocated to a matter of preference. Invest in what you know, as they say.

However, the first problem is a bit more pervasive. Most of us don’t have the knowledge base, analytical abilities or time to analyze companies one by one before making an investment.

So what’s an investor to do if they want to make sound investment decisions and avoid getting sucked into riding the wave of swing momentum trades?

That’s where thematic investing comes into play.

“Assets in thematic funds have grown at an average of 45% annually over the past three years.”

Fuse Research Network

Disclosure: This represents assets under management, and is not reflective of investment return. As of 12/1/2021.

Changing With The Times

A Whole New World

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The pandemic flipped many of the things in our world upside down.

One of those things included traditional beliefs that stocks in the same sector tend to move together. That long-held belief was undercut. Another result of the pandemic trading frenzy is that people now understand themes like cloud computing and collaborative software in ways they might not have before. “Invest in what you know, but smartly” has become the name of the game for many retailers who have experienced the extreme market valleys and peaks over the last two years.

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Another premise flipped on its head was the idea that retail traders are only meme-stock groupies.

However, in the fourth quarter of 2020 alone, thematic ETF assets shot up 78% to $104 billion, according to Global X Management Co. LLC. A significant amount of which came from retail traders purchasing thematic funds on a fractional share basis. Their aim? To weather the market volatility, hedge against their own inexperience, and make better bets to grow their net worth over the long-run.

So, what does thematic investing look like in action?

Say we are looking at targets for investment and the target group is mostly comprised of athletic apparel companies because we like working out and know all about the different brands. But more than just knowing differences between brands, we believe consumers will continue to prefer athletic apparel over traditional business-casual attire, and as a result, purchases of these goods will continue to rise.

There’s our investment thesis: “athletic apparel sales will continue to grow.”
A thematic portfolio of ‘athletic apparel companies’ might then include Nike, lululemon, Skechers, and Crocs.

These companies have widely different financial situations, different expertise within the athletic apparel industry, and a range of featured products. But the thematic portfolio as a whole is likely to benefit if our thesis holds true. And if one company outperforms while another lags and the other two are flat, well then we have a diversified investment to help hedge against the underlying risk from any one company.


Potential Risks & Fund Balance

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Thematic ETFs can carry risks just like any other investment product.

A new study by several finance professors finds that, on average, thematic ETFs hold only about one-quarter as many stocks as do broad-based funds. Fewer holdings can mean decreased diversification. Investing in only a slice of the market, instead of the entire market, lowers diversification and raises risk. If a theme appeals intuitively to one person, chances are it appeals to millions of other investors too, which can make a fund’s underlying holdings more expensive.

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Quirky rules of portfolio construction can also crop up.

Some funds limit any single stock position to a certain percentage of the fund’s total holdings. How the fund rebalances can affect its level of diversification. If the fund only reallocates proceeds from sales of positions that have grown too large (winners) it could create a situation where the fund becomes “top-heavy,” or heavily concentrated in a small handful of best-performing stocks, over time.

What We Learned

Key Takeaways

We believe successful investing starts by identifying broad trends within a sector or a specific market niche that is ripe for growth, and then identifying a thematic product that aligns with the trend we’ve spotted to invest in. Thematic ETFs allow for a greater degree of diversification than investing in single stocks, while still retaining a focus on the market niche of interest of a particular investor. The alternative is attempting to pick winners within a sector or industry. Which is fraught with risk and provides little if any diversification.

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Explore Our BAD ETFs

Carefully consider the investment objectives, risks, charges and expenses of The BAD Investment Company ETFs before investing. This and other information about each fund is contained in the Prospectus. Please read the prospectus carefully before investing as it explains the risks associated with investing in the ETFs.

These include risks related to investments in small and mid-capitalization companies, which may be more volatile and less liquid due to limited resources or product lines and more sensitive to economic factors. Fund investments may also be concentrated in an industry or group of industries, and the value of Fund shares may rise and fall more than more diversified funds. Investments in foreign securities involve social and political instability, market illiquidity, exchange-rate fluctuation, high volatility and limited regulation risks. Emerging markets involve different and greater risks, as they are smaller, less liquid and more volatile than more developed countries. Depositary Receipts involve risks similar to those associated with investments in foreign securities, but may not provide a return that corresponds precisely with that of the underlying shares. All investing involves risk, including possible loss of principal. Please see the prospectus for specific risks related to each fund.

BAD is distributed by Foreside Fund Services, LLC.