Thematic ETFs: why investors are looking beyond the headline story

This article was first published in our Direct Investor Magazine on 3 August

Thematic investing offers something different to traditional investing. Rather than tracking traditional indices, thematic exchange traded funds (ETFs) allow investors to express a view on structural changes such as AI, defence, semiconductors, space and more, that could reshape economies and industries over the coming decades. 

As the thematic ETF market has matured, investors have become far more selective about which stories deserve their capital. Providers have launched many thematic ETFs over the years, covering almost every emerging trend imaginable. While this has broadened investor choice, it has also created a clear divide between themes attracting sustained inflows and those experiencing effectively no inflows at all. 

The era of buying into every exciting narrative appears to be over. Today's investors increasingly want evidence that a theme is supported by visible earnings, government policy or long-term structural demand. Rather than asking whether an industry has an exciting future, they're asking whether the companies within it are already generating revenues, profits and sustainable growth. 

Read more: Active vs passive ETFs: the pros and cons

Investors are demanding evidence, not just narratives 

Defence has become one of the strongest-performing themes. Heightened geopolitical tensions across Europe, the Middle East and Asia, combined with NATO members committing to higher defence spending, have transformed the investment case. Many companies involved in military equipment, aerospace, defence technology and cybersecurity increasingly benefit from long-term government contracts, offering investors greater confidence in future earnings. Defence is now viewed less as a cyclical industry and more as a sector underpinned by multi-year spending programmes. 

AI remains another major beneficiary, although investor focus has evolved. Early enthusiasm centred on AI's transformative potential. Today, investors are increasingly allocating capital to businesses already monetising the technology, including semiconductor manufacturers, cloud infrastructure providers, data centre operators and software companies. 

Semiconductors have become one of the most important themes within technology investing. Chips underpin AI, cloud computing, smart phones, industrial automation and electric vehicles. Strong demand for advanced processors, combined with government efforts to strengthen domestic chip manufacturing in the US and Europe, have reinforced long term investor confidence. 

Cybersecurity has also regained momentum. As organisations become increasingly digital and cyber threats continue to grow in scale and sophistication, cybersecurity spending has become a business necessity rather than a discretionary IT expense. Governments, financial institutions and corporations continue to invest regardless of the economic cycle, giving the sector attractive structural growth characteristics. 

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Which themes are attracting capital?

Commodity-linked themes have also attracted renewed attention. Uranium has benefitted from a global reassessment of nuclear power as countries seek reliable, low-carbon electricity generation alongside renewable energy. Rising electricity demand from AI-driven data centres has strengthened the long-term outlook further. Rare earths remain strategically important because of their role in electric vehicles, renewable energy systems and defence technologies, although returns are often more volatile as commodity prices and geopolitics play a significant role. 

Read more: Uranium: fuel for thought

Why some themes have struggled 

But not every theme has maintained investor enthusiasm. Clean energy ETFs experienced sustained outflows during 2022 and 2023 as higher interest rates increased financing costs for renewable energy projects. While the long-term transition towards lower-carbon energy remains intact, investors became more cautious about the near-term earnings outlook. 

Robotics and automation have also seen mixed fortunes. Automation continues to address labour shortages and productivity challenges, but many companies in the sector remain exposed to cyclical industrial markets, making earnings more sensitive to economic slowdowns than many investors initially expected. This divergence highlights a broader evolution in thematic investing. Investors are becoming more disciplined, distinguishing between durable megatrends supported by strong fundamentals and themes driven primarily by market excitement. 

Retail investors remain natural adopters of thematic ETFs because the investment stories are intuitive and easy to understand. Themes such as AI or cybersecurity are often easier to explain than factor investing or regional asset allocation. Financial advisers frequently use thematic ETFs as satellite holdings to complement diversified core portfolios and express long-term convictions. 

Institutional investors have also shown more interest in thematic investing, although with greater selectivity. Rather than pursuing fashionable concepts, institutions increasingly favour themes supported by government policy, structural economic change and improving corporate fundamentals. 

Read more: Investing in a tripolar world: navigating new geopolitical realities 

Portfolio construction still matters

Like any investment strategy, thematic investing offers both opportunities and risks. Its greatest strength is providing exposure to long-term structural trends that may reshape industries over many years. These may be areas of innovation that are difficult to access through traditional sector investing. 

However, thematic ETFs are typically more concentrated than broad market funds, increasing company and industry-specific risks. Popular themes can also become expensive as investor enthusiasm drives valuations higher, reducing future return potential. Timing is another challenge, as many thematic funds are launched after a trend has already gained widespread attention. Investors buying after periods of strong performance may face disappointing returns if expectations prove too optimistic. 

Another important consideration is overlap. Some thematic ETFs hold the same large technology companies. Investors allocating simultaneously to AI, semiconductors, robotics and cloud computing may unintentionally build significant exposure to a relatively small group of stocks. 

The next phase of thematic investing 

Thematic investing is therefore best viewed as a complement to, rather than a replacement for, a diversified core portfolio. Used thoughtfully, thematic ETFs provide investors with a practical way to express long-term convictions and gain exposure to transformational trends.