Thematic investing is the belief that major trends are the key to big gains in the market. Thematic investors seek to get in at the ground floor of a movement before it takes off. Sometimes, this means buying and holding for years or at a loss. The theory is that an early enough entry point will yield significant, substantial returns as the theme comes to fruition. 

The best way to look at this investing strategy is to look at the rise of game-changing innovations in the past. Imagine buying into Netflix (Nasdaq: NFLX) in 2002, when the company IPO-ed as a movie-by-mail business. Investors bought in because of its potential to disrupt an established market. That was nearly 20 years ago and today, it’s a market-leader. 

Thematic investing is about recognizing the next big disruptive concept. More importantly, it’s about putting your money where your beliefs are.

Thematic investing is about trending stocks

A Macro Look at Markets and Thematic Investing

Thematic investing looks at concepts that exist on a larger scale than technical or fundamental investing principles. Instead of looking at any one specific company, investors look to fill a need. Once they identify a need, investors will find players. The approach is top-down, macro to micro. Let’s look at a modern-day example.

Cannabis is slowly becoming legal throughout the United States (and the world). This is a brand-new market with significant demand. Fledgling companies have stepped into the arena to meet that demand: growers, dispensaries, packaging outfits, equipment suppliers and more. While not legal at the federal level yet, many investors have opened buy-and-hold positions in these companies. 

This example of a macro trend has influenced investors to look at companies specific to the trend. Not only direct contributors, but also those in peripheral markets who could capitalize. The idea is that thematic ideas will bring sweeping change, heralded by the companies positioned to meet market demand. 

Thematic vs. Sector Investing

Thematic investing is often confused with sector investing. The two often go hand-in-hand, but remain unique concepts. Themes often affect entire sectors—namely technology, energy, financials or healthcare. But themes transcend sectors. They’re a larger force for change than any one sector can bear. Take 5G, for example. This major innovation is specific to telecom, but touches everything from manufacturing to healthcare. 

Thematic investors often target a sector to invest in where they believe the roots of change will manifest. That said, they’re not selecting the sector because of its potential—rather, they’re selecting the companies most qualified to meet the needs of a new theme, regardless of sector. 

Five Major Governing Themes

According global investment manager BlackRock, there are five specific governing forces in thematic investing:

  1. Urbanization
  2. Climate change and resource scarcity
  3. Shifting economic power and demographic 
  4. Social change 
  5. Technological breakthrough

These five themes all have the potential to disrupt entire sectors and markets. Some, more than others. For example, urbanization may affect the consumer discretionary sector far more than technology breakthroughs. Moreover, climate change will likely affect the energy and utility sectors more than healthcare or financials. 

As investors identify potential themes, they need to think critically about the sectors and industries central to them. Theme distills to sector, which distills to companies positioned to capitalize. 

Is Thematic Investing Misunderstood?

Some call it a gamble on the future; others call it forward-thinking intuition. The biggest conflict comes from our ability to look backward. Few people are good at predicting thematic changes with a high level of certainty. Therefore, many consider thematic investors as “lucky.”

Luck certainly has something to do with it. But there’s no substitute for sound analysis of trends, themes and companies. Often, the gap comes between identifying themes and identifying companies.

For example, many people may have seen cannabis legalization as an inevitability. However, short of a scattershot approach, they might not have invested in the right players. Emerging trends are dynamic, which means opportunities for disruption throughout their culmination. Realizing a trend and spotting the ideal investment rarely correlate. 

There’s one hedge against the swing-and-miss approach to thematic investing: ETFs. A basket approach to companies has a better statistical approach to hitting on a major player in an up-and-coming trend. Another option is to identify the top three or five companies poised to break out and keeping a consolidated portfolio. 

Thematic investing is subject to criticism and evangelism. Those who hit big on emerging trends and have the tenacity to hold for years or even decades see the truth in it. Those who miss the boat tend to be skeptical of anyone who claims they can predict the future. 

The Bottom Line

Thematic investing has the potential for huge payoffs. That is, if you’re patient enough to wait for the theme to take shape. If you bought into Netflix’s IPO in 2002, you’ll know it did relatively poorly until 2010. In fact, it didn’t really take off until 2014. That means more than a decade of holding! That’s the gamble thematic investors take. The company may skyrocket like Netflix… or it may fall flat and disappear.

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Thematic investing is often chided as speculation since the timeline for realization is so long. More than buying a lottery ticket, thematic investors need to have the foresight to see opportunities for disruption. Then, they need to pick investments with the power to become a disruptive force.