Thematic ETFs: Megatrend or fad trap?
Artificial intelligence, the energy transition, cybersecurity, outer space – people these days can invest in trends large and small at the click of a mouse. Thematic ETFs provide access to megatrends without investors having to focus on individual stocks. Their packaging is clever, the stories behind them are emotive, and their diversification is seemingly broad. Thematic ETFs promise access to the winners of tomorrow. In reality, though, investors not infrequently are actually buying yesterday’s winners.
From trend to investment product
The underlying idea behind thematic ETFs is simple. They invest not along traditional country or sector boundaries, but instead align themselves with long-term structural trends. Whereas a conventional sector ETF tracks an existing established industry such as technology or healthcare, a thematic ETF tries to make a hypothesis about the future investable. In so doing, thematic ETFs capture the spirit of the times. That’s because investors seldom think in terms of index methodologies, market capitalizations, or factor premia. They think in stories. A doctor understands the significance of disease diagnostics, a computer scientist comprehends the import of artificial intelligence (AI), and a military veteran grasps the relevance of defense industry companies. It’s hard, in contrast, to get through to investors with dry, prosaic risk premium theory.
Thematic ETFs have evolved into a sizable market over the past several years. Worldwide, approximately USD 468 billion was invested in 1,679 thematic ETFs as of end-November 2025, according to an analysis by ETFGI. But their popularity that has come into being in the wake of the euphoria surrounding the energy transition, defense, crypto and, most recently, AI is not a quality certification. The crucial question is not whether a trend is real (many are), but who earns money from it and at what price investors buy into it.
From a niche to a market worth billions | Thematic ETFs have reached adulthood
Assets under management and number of ETFs
Sources: ETFGI, Kaiser Partner Privatbank
Good story, bad timing?
The biggest flaw of many thematic ETFs lies not in the themes themselves, but in the timing of their issuance. A thematic ETF provider usually doesn’t launch a product until a technological or societal trend has generated enough public attention to sell it. By then, though, the stock market often has already priced in the usually bullish future expectations.
The pattern is familiar: some companies profit early on, their stock prices rise, media reports proliferate, and investor interest sprouts. Only then do investment products emerge that make the trend accessible to a wide public. That’s why thematic ETFs oftentimes are less a leading indicator and more a belated aftereffect of a market movement that is already well underway.
A current example of this was provided by SpaceX’s record-breaking initial public offering: in the runup to the IPO, investors frantically sought exchange-traded access to the spaceflight story, causing the fund size of a number of space ETFs to swell massively and prompting the launch of several new ones. This illustrates the typical timing problem associated with thematic products: the easy access to a trend often comes into existence precisely when it’s already on everyone’s lips.
FOMO in orbit | Space ETFs benefiting from the SpaceX hype
Assets under management in select space ETFs1, in USD billion
Sources: Bloomberg, Kaiser Partner Privatbank
Late isn’t automatically wrong. Some structural trends develop over decades. But even genuine trends can disappoint on the stock market if expectations are already too high. Clean energy, electric mobility, and the internet were structural changes and still are, but many investors earned poor returns on them during their respective hype stages.
From a fund problem to an investor problem
Mutual fund research provider Morningstar has been pointing out this problem for years. Many thematic funds have difficulty keeping pace with broad stock market indices over the long term. Although individual themes can earn spectacular returns over certain time spans, the picture often looks different over longer investment horizons: many products lag behind global equities or vanish from the market altogether if investor interest and fund volume wane. This doesn’t mean that all thematic investments are doomed to fail. It shows, though, that the bar to earning good returns on them is high – higher than the catchy logic behind the products suggests.
The problem becomes even more apparent when one examines the investor return gap, which measures not what a fund has earned on paper, but rather the difference to the fund’s return that investors have actually captured through their buying and selling. Put simply, the return gap tells whether investors have out- or underperformed the fund itself with the timing of their buying and selling. An investor who first buys in the wake of sharp price advances and then sells during a downturn gets less out of the investment than the reported fund return suggests. The return gap is often wide, particularly with thematic products. According to Morningstar, thematic funds earned an annualized return of +7.3% over the five-year period through June 2023 while investors earned just +2.4% due to their poor entry and exit timing.
The timing trap | Investors often arrive late to the party
Fund return vs. investor return (money-weighted) over five years
Sources: Morningstar, Kaiser Partner Privatbank
When the future is already priced in
The timing problem, though, is just the first hurdle. The second obstacle is a more fundamental one: a correct prediction about the future does not in itself constitute a successful investment strategy. That’s because the capital market is a discounting machine. It values future expectations, not the present. This is precisely why even companies in booming sunrise industries can turn out to be investment fiascos. Anyone who buys a theme isn’t purchasing its objective significance for the economy and society. He or she is buying the differential between today’s valuation and the future reality, and especially the future profitability. It’s exactly here where the most common faulty reasoning occurs: investors confuse a megatrend with an investment case. A megatrend answers the question of what’s gaining importance in the world. An investment case answers the question of which company can profitably capitalize on that and whether the price for it is attractive.
So, the crucial factor with trends is not how large the end market will become, but rather which companies are capable of lastingly maintaining pricing power and profit margins. The solar industry is a textbook example of this. Installed photovoltaic capacity has increased massively over the last 15 years, but many solar stocks have actually been lagging behind the world equity index. That’s because where there’s a lot of growth, there is also a lot of competition. And where many companies compete with each other, prices and profit margins fall.
Growth ≠ return | Solar boom without a stock boom
Solar stocks vs. MSCI World index and cumulative installed photovoltaic capacity
Sources: Our World in Data, IRENA, Reuters, Bloomberg, Kaiser Partner Privatbank
Passive wrapper, active construction
A third issue is often underrated: thematic ETFs have the appearance of being passive, but are anything but neutral in the way they are put together. The most important active decision already occurs in defining the theme. Which companies fall under the heading “AI”? What is a “space” company? How much corporate revenue should derive from the theme?
In the case of narrowly defined or new themes, the investment universe is often small. Thematic fund providers therefore usually have two options in such instances. The first option is to offer unalloyed access to a theme via “pure plays.” “Pure-play” companies are closely connected to the theme, but are often small, unprofitable, expensively valued or, in many cases, not listed on a stock exchange. This results in narrowly concentrated portfolios with few companies and correspondingly high single-stock and sector risk.
The second option is to take a broader-based approach. To enlarge the portfolio, companies with a faint connection to the theme also get included. A space ETF thus can contain defense companies, satellite operators, semiconductor manufacturers, or telecom corporations. Although that’s not wrong per se, it does show that these thematic fund products buy not the pure idea, but rather a methodological interpretation of the idea.
How a fund is constructed is crucial for investors. Two ETFs with the same name can harbor completely different risks: one is sharply concentrated on a few high-growth companies whereas the other ultimately resembles a slightly re-labeled technology index. Hence, the product’s name often reveals less about the portfolio than investors suppose – the risks and side effects are disclosed, if at all, in the fine print. And another thing should not be forgotten, particularly with regard to narrowly defined themes: even an ETF containing several dozen stocks can end up being a sector concentration. If all companies are sustained by the same theme, it thus often happens that in times of crisis, not just one company plunges, but the entire story does.
Marketing or value added?
Thematic ETFs are also a product of the competition in the mutual fund industry. Conventional broad-based ETFs on global stock indices are interchangeable and cheap. Their margins are slim, and differentiation is difficult. Thematic products can be marketed more aggressively and priced more expensively. That doesn’t necessarily have to be an exclusion criterion for investors. Good products can be well marketed and are worth paying a little extra for. It only becomes problematic if the narrative is more compelling than the actual investment logic: is there a sufficiently wide universe, plausible winners, reasonable valuations, transparent index rules, and a risk profile that fits with an investor’s existing portfolio?
That last point in particular frequently gets underrated. Many investors already hold considerable exposure to Nvidia, ASML, Alphabet, and other beneficiaries of major trends through global stock indices. An additional AI or digitalization ETF accordingly can reduce rather than increase diversification. Thematic ETFs are thus sensible mainly as satellite positions around a broadly diversified core portfolio, not as a substitute for the core. Furthermore, anyone who employs thematic products should do it calculatedly, to a limited extent, and with a fairly long time horizon.
Seeing the future correctly is not enough
Thematic ETFs are a reflection of a financial world that turns every major change into an investable product. That’s essentially a good thing. Capital markets fulfill an important function by pooling future expectations and giving investors access to structural developments. Thematic ETFs can additionally help investors to play their convictions in a controlled manner instead of speculating on individual trendy stocks. A good theme, though, isn’t necessarily a good investment.
So, what matters is not just whether a trend is a momentous one, but whether it remains attractive at today’s prices, with this specific portfolio, and embedded in the investor’s overall asset allocation. An investor who takes this distinction seriously will neither shun thematic ETFs on principle nor buy them indiscriminately. He or she will see them for what they are: useful but challenging tools to work with. Especially bear in mind that appraising the future correctly is not enough on the equity market – what crucially matters is whether the future is not yet fully priced into stocks.
1 Tema Space Innovators ETF, FSITC Cathay Aerospace and Satellite ETF, Hanwha ARIRANG iSelect Aerospace & Defense ETF, ARK Space Exploration & Innovation ETF, Gabelli Commercial Aerospace & Defense ETF, VanEck Space Innovators UCITS ETF, SPDR S&P Kensho Final Frontier ETF, Procure Space ETF