Is Thematic Investing Right for You?

In 1848, James Marshall discovered flakes of gold in a streambed near the water-powered sawmill he was building in Coloma, California.

As news of the discovery spread, roughly 250,000 prospectors flocked to the state in search of their own fortunes. While many gold-seekers went bankrupt, purveyors of essential goods and services—including denim, saloons, and shovels—saw their wealth explode.

In retrospect, the California gold rush illustrates the principles behind thematic investing, which identifies companies across various industries that form part of a concept or trend. With this approach, you can invest not only in the headliners of the next big thing but also in a diverse cast of supporting players that could continue to thrive even after the trend itself has faded.

Thematic investing has existed in public markets since at least 1948, with the launch of the Television Fund, which sought to profit from all things TV just as color sets were about to debut. However, not all themes are as obvious as TV—and even then, investors had to rely on a fund company to prepackage and present the opportunity.

Today, it's a different story. Advances in technologies like natural language processing make it possible to mine corporate communications—such as earnings reports, regulatory filings, and other public information—in search of common keywords supporting a theme, often revealing an unexpected web of interconnected companies.

"The concept of thematic investing isn't new, but new technologies have made it easier to uncover a universe of potential opportunities," says Inga Rachwald, a senior portfolio strategist for Schwab Asset Management.

While there's no shortage of ideas out there—nearly 600 thematic funds debuted in 2021 alone, with managed assets topping more than $800 billion globally¹—deciding among the possibilities is highly personal. "Today's thematic investing allows you to pursue your interests beyond traditional boundaries like market sectors or the obvious industry leaders," Inga says.

For example, consumers of electric and hybrid vehicles might see an opportunity to invest in automakers, but also mining companies that source the rare earth metals required for next-generation car batteries. In a similar vein, those who anticipate the expansion of health care access might invest not only in medical-service providers but also technology companies transforming the delivery of care.

Whatever theme you decide to pursue, you want to be confident it has legs. "Unlike fads that can flame out in a matter of weeks or months, thematic investing involves big ideas that could take years to play out, assuming they don't peter out altogether," says Matt Wilson, director of digital wealth offers and planning at Schwab.

For example, technological advances in genomics research have made it possible to diagnose, treat, and even predict genetic disorders more precisely. At the same time, the field is rife with ethical questions and other potential pitfalls that could limit its progress. "As with any investment, your thematic holdings should align with your risk tolerance and time horizon," Matt says.

Once you have a theme in mind, you generally have two ways to access it:

If you want control over the companies you hold—and your allocations to each—you may wish to invest in a theme via individual stocks. That said, it can be challenging to distinguish and vet relevant companies on your own, to say nothing of regularly reviewing their business models to ensure they continue to be a good fit. "Even experienced, savvy investors may find it difficult to identify a range of appropriate companies for a given theme," Inga says.

This is where offerings such as Schwab Investing Themes™, which uses proprietary research to identify viable trends and vet relevant companies, can help. You choose the theme that appeals to you and invest in a ready-made list of relevant stocks—or customize the list to suit your particular passions or objectives. "Rather than starting from scratch, investors using this latest iteration of thematic investing can easily and efficiently find suitable options," Matt says.

Be aware, however, that the stocks included in a theme are not recommendations and may not perform as intended. What's more, natural language processing and related technologies can suffer from the same biases inherent in any human endeavor. As with any investment, you should do your own due diligence to ensure any stocks you trade align with your expectations and your overall investment strategy.

For investors who don't want to manage a portfolio of individual stocks, a thematic mutual fund or exchange-traded fund (ETF) could be a good solution. Keep in mind that these funds generally offer broad, rather than targeted, exposure to a specific theme. Additionally, they typically aren't required to invest all their assets in companies relevant to their theme. A fund's management fees should also be considered, as they can compromise your overall returns.

How you define success for your thematic investments should be based on your personal goals for those holdings. For example:

• If you're looking for a specific return, be sure to have a return target and time frame in mind. If your holdings don't meet those expectations, you'll need to figure out why. Were your expectations too high? Did the theme fail to materialize? From there, you can assess whether you need to modify your holdings or rethink your thematic strategy.
• If you're investing based on personal interests, you'll need to regularly monitor your holdings to ensure they're still living up to your standards and adjust accordingly.

If you invest via thematic funds, you also should keep an eye out for style drift, in which a fund manager invests in holdings that don't quite fit the stated strategy, perhaps in search of better returns. Even if the fund is performing as (or better than) expected, style drift can be cause to reassess whether a fund still matches your thematic goals.

Many of today's most compelling themes are the outgrowth of a changing world—and change can take time to fully materialize. As a result, it's best to approach thematic investing with a long-term mindset and an understanding that some themes may never live up to their potential. It's not about chasing what's trendy; it's about participating in an idea you believe in.

Whatever theme you pursue, consider how the holdings will fit into your overall asset allocation. "Given that thematic holdings could span countries, sectors, and even market capitalizations, it's prudent to consider them as part of your total global equity allocation," Matt says.