One of the key elements of a generally healthy investment portfolio is diversification, or not putting all your eggs in one basket, financially speaking.
A diversified portfolio can help protect investors from significant losses if a single company or sector in which they invest faces a major downturn. As an extreme example, if you put all your life savings into Apple stock and the company suddenly goes bankrupt, you’d be in a bad place. However, if your investments are spread across a variety of companies, such as Apple, Walmart, Johnson & Johnson, etc., you can generally reduce the risk of your portfolio, since it is less likely that all companies will underperform at the same time.
That begs the question. Why would investors be interested in investment funds that focus on a single sector? Thematic exchange traded funds are ETFs that are tied to a specific industry, such as artificial intelligence or space exploration, or more broadly to a theme, such as natural resources or infrastructure. Investors, especially young people, are increasingly adding these types of funds to their portfolios.
“Thematic ETFs can be a great complement to existing (diversification) strategies because they allow investors to double-click on investment themes and increase exposure to investment themes,” said Todd Rosenbluth, head of research and editorial at investment research firm TMX VettaFi. These funds “often invest in companies that are smaller and have more targeted exposure to specific themes.”
Investors poured about $95 billion into thematic ETFs in 2020 and 2021, according to a new Morningstar analysis. Many investors then exited the fund between 2022 and 2024, but have since returned, with net inflows into thematic ETFs totaling $76 billion since December 2024, the analysis found.
Perhaps unsurprisingly, AI-themed ETFs are leading the way, with investments in the industry accounting for nearly a third of inflows, according to Morningstar.
“I think people are confident in the long-term (AI) trends,” Rosenbluth said.
Thematic ETFs especially resonate with Gen Z investors. In Nasdaq’s 2024 Retail ETF Investor Survey, young adults were the most likely to say they were interested in thematic ETFs. According to the survey, approximately 75% of Gen Z investors (born between 1997 and 2021) have ETFs in their retirement accounts, and 34% of Gen Z investors said they are interested in thematic funds. The survey was conducted in March 2024 among 2,000 individual ETF investors and has a margin of error of plus or minus 2 percentage points.
“[Younger investors]are more accustomed to ETFs than older investors because they are less prevalent and relevant than their parents’ generation,” Rosenbluth said. “Younger generations are more likely to take on some risk appropriately through the stock market and have more time for these strategies to take hold.”
Here are some tips he says Gen Z investors and anyone interested in thematic ETFs should consider.
1. Diversify your themes
While it’s technically possible to build a diversified portfolio through several different ETFs of the same theme holding different companies, it’s wise to invest in a variety of themes to widen the scope of your portfolio.
“You can reap the benefits of making artificial intelligence an overarching theme,” Rosenbluth says. “However, any slowdown in spending on artificial intelligence would have a negative impact on related ETFs.”
Tech and AI stocks have generally performed well in recent years, sometimes driving the market to record highs. But these are not the only industries that can deliver solid returns to investors.
“There are other sectors outside of technology that are doing very well or could do very well, so there are benefits to diversification,” he says. ETFs with utilities, space exploration and infrastructure themes could be of interest, he added.
2. Make sure thematic ETFs complement your portfolio
If you’re looking for a good thematic ETF to invest in, Rosenbluth added, it should complement your portfolio as well as increase exposure to large-cap stocks you already own. This can easily happen if you have broad investments in indexes like the S&P 500 or Nasdaq-100.
Rosenbluth says he uses the fact that ETFs disclose their holdings daily to see the variety of stocks available.
“If you’re not aware of all the stocks in your top 10 portfolio, that’s OK,” he says. “Assuming you trust that the ETF provider, the index provider behind it, is doing the right thing, it’s good to not have Apple or Microsoft in your thematic ETFs, because you’re going to have up-and-coming companies coming in that could potentially benefit you.”
3. Do your research
Rosenbluth recommends that investors not only look at the companies an ETF owns, but also look at the ETF provider to see “if you like what they’re doing.”
Pay attention to the ETF’s fee structure, whether it is actively or passively managed, and its analyst ratings, which can reveal the ETF’s efficiency in terms of performance, costs, and other factors.
