How Thematic Strategies Differ from Sector Funds

February 16, 2024
Thematic investing strategies can help you diversify in different ways than a sector-based fund might—just make sure you know what you're buying.

Part of the appeal of thematic investment strategies is that they can venture beyond traditional sector classifications when bundling stocks, potentially giving you new ways to diversify.

Here we'll take a closer look at how themes and sectors differ, and how thematic strategies can give you a targeted exposure to different parts of the economy.
 

What's in a bundle?

Let's start with sectors, since those are perhaps the more familiar of the two. 

Standard & Poor’s and MSCI created the modern system for grouping and classifying stocks by industrial sector when they launched the Global Industry Classification Standard (GICS®) back in 1999. Under this framework, companies are sorted into one of 11 sectors according to their principal business activity—consumer discretionary, communication services, consumer staples, energy, financials, health care, industrials, information technology, materials, real estate, and utilities—as determined by revenue sources and other factors. Each sector also contains subdivisions for industry group, industry, and sub-industry. Every company within a sector is assigned one classification in each of those tiers. 

Standardized sector and industry definitions paved the way for investing strategies such as sector-focused exchange-traded funds (ETFs). Such funds can be useful if you expect a certain sector to do better—or worse—than the rest of the economy over a given period. 

Because they can include all the stocks in a sector, sector ETFs can offer a measure of diversification beyond what you might get if you'd invested in just a handful of stocks.

Like sectors, thematic strategies also group together companies and slices of the economy, but they have a different way of doing so. They may target ideas or trends—especially new or potentially transformative technology or social forces—that don't fit squarely into the existing classifications. 

As a result, thematic strategies can be both more targeted than sector-based ones, at least insofar as they focus on a particular idea or trend, and more broad-based, because they can consider stocks from any industry or sector, so long as they are relevant or consistent with the theme. Additionally, a stock can be relevant to any number of themes, whereas it will only ever belong to one sector. Finally, sector designations tend to be backward-looking, since they depend on a company's current or past business activity, while thematic strategies can focus on a business's potential future business opportunities. 

Of course, thematic relevance is somewhat subjective. Themes don't have recourse to a GICS equivalent to arbitrate differences between investment offerings or determine which ones should be included where. Every strategy will reflect the views of the research provider, so be sure you do your research before deploying a thematic strategy. 

Sectors vs. themes

Here are some examples to clarify these differences. The chart below shows four technology-oriented Schwab Investing Themes™:  artificial intelligence, big data, cloud computing, and cyber security. As you can see, each theme starts with a heavy dollop of stocks from the information technology sector, but then diverge. 

Different shades of tech

Chart compares four tech-oriented themes with different sector compositions. Artificial intelligence is about 61% information technology, about 23% communication services, 9% consumer discretionary, and small allocations to industrials and financials. Cloud computing is about 69% IT, 11% real estate, , and 10% communication services, and 10% consumer discretionary. Big data is about 83% IT, 11% industrials, and 6.4% health care. Cyber security is about 95% IT and 5% industrials.

Source: Schwab theme allocations as of 11/30/2023.  For illustrative  purposes only.

For example, the artificial intelligence theme includes a large contingent of information technology companies, but the rest come from the communication services, consumer discretionary, and financials sectors. The cyber security theme, on the other hand, draws almost entirely from information technology stocks.

Themes concentrated within a single sector can also differ significantly from funds tracking those sectors by virtue of what they exclude. For example, 100% of the stocks in Schwab’s dining out theme come from the consumer discretionary sector, but the exposure it provides would likely be quite unlike what you might get from a sector-focused fund. Why? The theme includes 25 companies, and they are concentrated in the consumer discretionary sector's restaurant sub-industry. In contrast, a fund tracking the S&P 500 Consumer Discretionary Index would likely include 52 companies, with online retailer Amazon and electric carmaker Tesla occupying the largest weightings. That may not a bad thing, but an investor looking for exposure to restaurants might opt for a more targeted approach.

A perhaps more surprising example comes from Schwab's U.S. housing theme, which you can see below. 

Building a theme

Pie chart showing Schwab's U.S. Housing theme consists of 71.8% consumer discretionary stocks, 18.2% real estate stocks, 6.6% financials, and 3.4% industrials.

Source: Schwab theme allocations as of 11/30/2023. For illustrative purposes only.

You might expect a housing-focused theme to include quite a few real estate companies, but real estate accounts for only about 18%. Consumer discretionary stocks, with a nearly 72% weighting, are the largest sector in this theme—as large homebuilders such as DR Horton and Lennar Corp reside there. Financials, including some mortgage and titling companies, make up about 7%, while industrials round out the rest. 

To be sure, these are just a few examples from Schwab's offerings. Other providers' thematic strategies might pursue similar goals with totally different holdings or sector concentrations, depending on their models and research. 

No matter how a thematic strategy allocates, it's probably still going to look different from even superficially similar sector-focused alternatives. And such differences can be the building blocks of additional diversification.   

Making themes work

Of course, diversification only makes sense in the context of your portfolio. Thematic strategies on their own won't give you a diversified portfolio, so it's essential to determine how one might work with the rest of your holdings—especially if you rely on funds tracking market-cap weighted indexes.

Such funds can automatically provide a lot of exposure to certain large companies, so employing a thematic strategy that increases your exposure to those companies could make your portfolio less diverse. Similarly, there's no rule preventing a particular stock from appearing in multiple themes, be sure to review the list of stocks in a theme before you invest. 

That said, how you're investing matters. If you're using a thematic fund, you might not have any say over what stocks are included. If you're using a theme-based stock list, though, you may be able to exclude certain companies to avoid unwanted concentration.

Thematic strategies can help you explore otherwise untapped parts of the market and add a new dimension to your portfolio—but only if you use them correctly.  

Next steps

Learn more about thematic investing at Schwab.

Please read the Schwab Investing Themes™ Terms and Conditions.

Data provided by multiple sources, including third parties. While Schwab believes such third-party information is reliable, we do not guarantee its accuracy, timeliness, or completeness.

Investment Research for Schwab Investing Themes™ is provided by Charles Schwab Investment Management, Inc. ("CSIM"). CSIM is an affiliate of Charles Schwab & Co., Inc. ("Schwab"). Both CSIM and Schwab are separate entities and subsidiaries of The Charles Schwab Corporation.

Schwab Investing Themes is for informational purposes only; it is not intended to be investment advice (including fiduciary advice as defined under the Employee Retirement Income Security Act or the Internal Revenue Code) or a recommendation of any stock. Investing in stocks can be volatile and involves risk, including loss of principal. Consider your individual circumstances prior to investing. Past performance is no indication or guarantee of future results.

The Global Industry Classification Standard (GICS®) was developed by S&P Dow Jones Indices, an independent international financial data and investment services company and a leading provider of global equity indices, and MSCI, a premier independent provider of global indices and benchmark-related products and services and has been licensed for use by Schwab.

Orders placed online through Schwab Investing Themes will have $0 commission. However, the standard online $0 commission does not apply to restricted stock transactions. Exchange process, American Depositary Receipt (ADR), and foreign transaction fees still apply. See the Charles Schwab Pricing Guide for Individual Investors for full fee and commission schedules.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. 

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed. 

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk, including loss of principal.

Thematic investing involves risk including loss of principal. The strategies are generally non-diversified and concentrated in the securities of issuers in a particular market, industry, group of industries, sector, country or asset class. As a result, a single adverse economic or regulatory occurrence may have a more significant effect on the strategies investments, be more vulnerable to adverse economic, market, political or regulatory occurrences, and may experience increased volatility than other strategies with greater diversification.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

The information and content provided herein is general in nature and is for informational purposes only. It is not intended, and should not be construed, as a specific recommendation, individualized tax, legal, or investment advice. Tax laws are subject to change, either prospectively or retroactively. Where specific advice is necessary or appropriate, individuals should contact their own professional tax and investment advisors or other professionals (CPA, Financial Planner, Investment Manager) to help answer questions about specific situations or needs prior to taking any action based upon this information.

All corporate names and market data shown above are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security. Supporting documentation for any claims or statistical information is available upon request.

0224-60NW