Be Thoughtful About Thematics

Thematic investing allows investors to tap into companies at the forefront of big picture trends and the potential to capture market-beating performance. However, if investors are not careful, they could find themselves overexposed in certain areas and not understanding the implications of their investment on the rest of their portfolio.

In recent years, there has been an increasing number of funds launched with the intent of capturing themes like blockchain, climate change, cybersecurity, robotics, video games and more. While these funds may have very focused mandates, the type of companies included may cut across traditional sector classifications. This may be particularly true for themes in which there are few publicly traded companies and large conglomerates with only tangential business exposure to the theme included. Ultimately, it is up to investors to "look under the hood" and make sure they understand how companies are selected for a strategy and if the companies included provide the differentiated exposure they are seeking.

Legacy Themes: Strategies Trend Towards High Overlap and Correlation

Thematic strategies tend to vary in level of diversification. Sectors that have existed for longer periods of time exhibit similar characteristics across funds, while newer and niche themes have portfolios that are less diversified. Building a pure-play portfolio, a basket of securities that represent a particular sector without diluting its focus, has proven to be difficult for ETF issuers entering the new thematic segment of the market.

We have seen this trend play out over the years. Established investment themes such as oil and semiconductors have had similar exposure and performance, since inception. Two of the most-followed oil services indexes, MVIS^® US Listed Oil Services 25 Index and Dow Jones U.S. Select Oil Equipment & Services Index, have an overlap of 85% when comparing constituents, while the two most-followed semiconductor indexes, MVIS^® US Listed Semiconductor 25 Index and PHLX SOX Semiconductor Sector Index have an overlap of 77% when comparing constituents. These two comparative indexes have performed similarly over the past ten years, largely due to an abundance of companies in the sectors that allow for a similar investing strategy while diversifying a minority of holdings.

Legacy Theme: Oil Services Exhibit Similar Performance

7/14/2006 – 3/31/2021

Source: Morningstar Direct as of 3/31/2021.

Legacy Theme: Semiconductors Exhibit Similar Performance

12/22/2009 – 3/31/2021

Source: Morningstar Direct as of 3/31/2021.

Newer Thematic Strategies Demonstrate Less Overlap and Correlation

Newer themes such as clean energy and robotics have a much more varied approach to strategies with performance widely diverging based on the focus of their holdings. Clean energy indexes have overlap ranging from 10-25%, and the positive outlier in the peer group (MAC Global Solar Energy Index) has differentiated itself with a pure-play approach to solar energy, in particular. Robotics and artificial intelligence funds have followed a similar trend, with an overlap of just 6-25% across funds and varying performance records.

Nascent Theme: Clean Energy Exhibits Divergent Performance

11/13/2017 – 3/31/2021

Source: Morningstar Direct as of 3/31/2021.

As a fairly new but nascent field, companies that are purely focused on robotics and AI are limited, so portfolio managers must make the decision of where to diversify. Differences in index exposure are ultimately determined by differences in the index rules, so it is very important for investors to understand an index’s rules and have a solid grasp of the underlying constituents.

Nascent Theme: Robotics Exhibit Divergent Performance

12/18/2017 – 3/31/2021

Source: Morningstar Direct as of 3/31/2021.

Investors have grown more inclined to own funds that represent their own interests and ideals, but it is important to remember that a basket of stocks presented as a certain theme may not always be the most direct approach to that industry. While emerging trends can exhibit significant differences across fund offerings, potential investors must keep in mind that these may be long-lasting trends that will see more companies enter the market in coming years. Thematic investing provides opportunities for investors to invest in the future. However, they should take the time to know what they would potentially own, and understand the possible material differences between strategies claiming to cover the same or similar themes.

Index Definitions

MVIS^® US Listed Oil Services 25 Index - tracks the performance of the largest and most liquid US-listed companies that derive at least 50% of their revenues from oil services.

Dow Jones U.S. Select Oil Equipment & Services Index - measures the performance of U.S. companies in the oil equipment & services sector.

MVIS^® US Listed Semiconductor 25 Index - tracks the performance of the largest and most liquid US-listed companies that derive at least 50% of their revenues from semiconductors.

PHLX SOX Semiconductor Sector Index - companies primarily involved in the design, distribution, manufacture, and sale of semiconductors.

Ardour Global Extra Liquid Index - includes only those companies that are principally engaged in the field of alternative energy and excludes those companies in which alternative energy is peripheral to their main business.

S&P Global Clean Energy Index - measures the performance of companies in global clean energy-related businesses from both developed and emerging markets, with a target constituent count of 100.

MAC Global Solar Energy Index - tracks the global solar energy equity sector; includes companies listed on exchanges in specified countries that derive a significant amount of their revenues from solar business activities.

Wilder Hill New Energy Global Innovation Index - composed of companies worldwide whose innovative technologies focus on clean energy, renewables, de-carbonization, and efficiency.

Indxx Global Robotics and AI Index - tracks the performance of companies that are expected to benefit from the increased adoption and utilization of robotics and artificial intelligence (“AI”).

NYSE FactSet Global Robotics and Artificial Intelligence Index - tracks the performance of globally listed companies involved in Robotics and Artificial Intelligence.

ROBO Global Robotics and Automation Index - global companies specifically engaged in the development and application of robotics, automation, and artificial intelligence.

Nasdaq CTA AI & Robotics Index - tracks the performance of companies engaged in the artificial intelligence and robotics segment of the technology, industrial, medical and other economic sectors.