From trackers to toolkits: thematic funds are the next chapter in ETFs

QuotedData has recently expanded its ETF coverage to include thematic ETFs. What has driven this change? And what exactly are we talking about when we talk about thematic ETFs? By David Batchelor

To answer this, we need to take a step back. There was a time when ETFs were the boring bit of the fund market. That was not a criticism – indeed, to an extent it was the whole point. They were simple, low-cost, transparent vehicles that allowed investors to buy broad exposure to a market without having to pay an active manager to pick stocks.

Buy the S&P 500, buy global equities, buy government bonds – job done. There was a pleasing neatness to this: the investor knew what they were getting, the provider tracked an index and the wrapper did its job.

That offer remains as strong as ever, with the largest and most successful ETFs still providing cheap, liquid, diversified exposure to the world’s deepest markets. Indeed, this month has seen the world’s biggest – the Vanguard S&P 500 ETF (VOO) – become the first ETF to break through the $1trn mark. For many investors, these products remain among the best innovations the fund management industry has ever produced.

However, the ETF market no longer stops there. ETFs have evolved from simple market trackers into something much broader: an investment toolkit. Investors can now use ETFs not only to buy “the market”, but to buy a sector, a commodity, an options strategy or a long-term theme.

This evolution explains why QuotedData’s ETF coverage is broadening too. When we started covering ETFs last year, our initial focus was narrowly on active ETFs. They are one of the most interesting recent developments in European asset management, and the experience in the US suggests that they have a very high ceiling indeed. They also raise a number of important questions, including: how active are they really? How transparent should they be? And will European investors embrace them in the same way that US investors have? We have tried to address these questions – and will continue to do so.

But active ETFs are only one part of the bigger ETF story, and thematic ETFs deserve the same level of scrutiny because they show just how far the wrapper has moved from its original role. That is why we have broadened our sector coverage to also include all things thematic.

What is a thematic ETF – and what is it not?

A thematic ETF is not usually designed to give investors exposure to a traditional asset class. Instead, it is designed to give them exposure to an idea, from artificial intelligence, clean energy and robotics to defence, space technology and ageing populations. These are not conventional market categories but are instead attempts to capture long-term structural change.

A thematic ETF begins with a concept. That concept is then translated into an index, either by selecting an existing benchmark or by creating a new one with a defined methodology. The ETF then tracks that index, meaning the portfolio is shaped by the index rules, including which companies are eligible, how they are weighted and how often the fund is rebalanced. In other words, while most thematic ETFs are passive, they are never free from judgement.

Investors often think of the ETF market in a simple active-versus-passive framework, with active ETFs involving a portfolio manager making decisions, while passive ETFs follow an index. Therefore, passive must be straightforward – but that is not always true. A thematic index is not handed down from the heavens. It is built, and its rules reflect choices about definitions, exclusions, liquidity, concentration and more.

Take artificial intelligence as just one example. One AI ETF might be dominated by the largest US technology companies because they are providing the chips, cloud infrastructure and software platforms that power the AI buildout. Another might try to capture robotics, automation and data analytics, or companies applying AI in healthcare and industry. All can plausibly be described as AI funds, but they are not giving investors the same exposure.

At their best, thematic ETFs give investors access to long-term trends that would otherwise be difficult to research stock by stock. They can package a complex opportunity into a tradable, transparent and relatively low-cost structure. However, there is a risk that a narrow thematic fund can still be concentrated, volatile and expensive relative to broad market exposure, or heavily exposed to stocks investors already own elsewhere.

Thematic ETFs can also be launched at exactly the moment when a theme is most fashionable and valuations are already stretched. Providers do not usually launch funds around ideas nobody is talking about; they launch them when they believe investors will listen. But investors need to be careful to separate the durability of a theme from the attractiveness of the current price. For example, renewable energy is a crucial part of the future of the global economy – but that did not prevent clean energy funds from experiencing painful drawdowns as interest rates rose from 2022. Similarly, AI may reshape entire industries, but that does not mean every AI-labelled portfolio is automatically a sensible holding at any valuation.

The role of research

ETF research therefore has to move beyond the old comfort zone, and that is why QuotedData’s offering is broadening. Active ETFs – where the market is still developing and where new entrants are trying to challenge the dominance of established providers – remain a key area of focus. But the wider ETF market is changing too. Thematic products are part of that change, and investors need help understanding what sits beneath the headline label.

ETFs have been an enormous success because they solved real problems. They made investing cheaper, more transparent and more accessible. Those advantages remain. But as the wrapper has expanded into more specialised areas, the work required from investors has increased too. The original promise of ETFs was that investors could buy the market efficiently. The modern promise is broader: investors can use ETFs to build portfolios, express views and access specific long-term trends.

The question is therefore no longer just whether an ETF is cheap, liquid and tradable. It is whether the exposure is understood. The wrapper may be simple, but the fund may not be. That is the gap QuotedData wants to help fill.

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