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Thematic investing has become a popular way for investors to get targeted exposure to specific investment themes, market trends, and values. Thematics can provide exposure to unique opportunities not captured by traditional sectors or allocations. But what are the characteristics that make for a good investment theme?
We have covered this topic in the past in our paper Investing in Thematics, but to summarize here:
Trend, not a fad — A good theme is a long-term, durable trend with far-reaching disruptive implications, not a transient fad. Simply put, today’s theme is tomorrow’s sector. A good way to distinguish an investment theme from a fad is that it has economic underpinnings supporting its investment thesis. NFTs and SPACs are two recent ETF investment themes that failed to succeed for that reason.
Megatrends — Some themes are so disruptive and far-reaching in their impact that they qualify as “megatrends.” Megatrends are long-term, secular trends with a global scale, such as climate change, demographic shifts, digitalization, decentralized finance, and, most recently, artificial intelligence.
Underlying regulatory support — When thematic disruption and government regulation align, it can help propel an investment theme.
Investable themes — Often a theme is so nascent that it is not yet investable as there are too few companies with “pure-play” exposure. Investors need to ask themselves, are these companies really a good proxy for this investment theme? Do these companies derive meaningful revenue exposure from the theme, and/or are they dominant players?
Exponential growth — Linear thinking often underestimates the parabolic growth potential of exponential, transformative change. Think about the recent inflection point in artificial intelligence created by the generative AI moment and the subsequent “hockey stick” pattern of surging growth and investment.
Timing - One of the key challenges of thematic investing is picking the right theme at the right time. Despite their long-term potential, investment themes, like stocks themselves, often experience pullbacks or setbacks and are not on a straight upward trajectory.
Selection/Allocation decision — Another challenge for thematic investors is which themes to select and how much to allocate to them as investments. And what is the appropriate percentage allocation to thematics in general?
Few “pure play” companies — As mentioned, with nascent themes, it is often difficult to get “pure-play” exposure from publicly traded companies without sacrificing diversification. There may only be a handful of public companies actually deriving meaningful revenue from a theme.
Overlapping exposure — A company such as Nvidia is involved in many important themes, from artificial intelligence to video gaming to autonomous vehicles and robotics. As a result, investors investing in multiple themes can easily become overexposed to specific companies.
Trading and tax considerations — Even if you get the timing right on a theme, trading is often constrained due to capital gains and other tax considerations.
The VettaFi Index team has come up with an index solution that solves many of the challenges associated with thematic investing.
Factor-based timing — Each quarter, the index selects the top themes based on a combination of aggregate quality and momentum scores to form an equal-weighted thematic index portfolio.
Turn-key thematic solution — Our index approach solves for “where do thematics fit into your portfolio.” Rather than leaving it to the investor to select the “best theme” on a timely basis, theme selection and weighting allocation are determined cross-sectionally, based on systematic, definable investment factors for the aggregate theme. The end result is a turn-key thematic solution.
Allows for pure-play exposure to nascent and sub-themes — Product issuers often face delays getting new themes to market. With our index approach, nascent themes (such as quantum computing) and sub-themes (like humanoid robots) can be included on a more timely basis, even if they do not yet meet the diversification requirements for an ETF index.
Overlapping exposure adjustment — If a company appears in multiple themes, its weight is the sum of its individual weights across those themes. A single-stock weight cap of 8% is applied to avoid overconcentration in any particular company.
Solves for trading and tax constraints — Our multi-thematic index rotation solution solves for trading and tax implication constraints.
The VettaFi Thematic Rotation family of indexes utilizes a systematic approach designed to provide tactical rotation to relevant themes. This strategy aims to address the non-linear and dynamic nature of innovation in thematic investing, providing investors with timely exposure to investment themes.
The first live example of this index approach is the VettaFi Thematic Rotation Quality Momentum Index (TRQM). The Index is reconstituted quarterly and composed of VettaFi’s top themes, as measured by momentum and quality, from VettaFi’s theme universe. The selected themes are equally weighted to form a thematic index portfolio composed of the current highest-rated themes.
Constituents of portfolios that represent themes in VettaFi’s theme universe. The Universe is composed of themes that are VettaFi index or sub-index themes. The Index Committee is responsible for making decisions on theme inclusion when there are questions regarding representation or eligibility.
Each theme receives a composite score, weighted between Momentum (40%) and Quality (60%) components. Themes are ranked by composite score, and selected in descending order until at least 7 themes and 125 companies are represented. When two themes have common ICE sub-industries that overlap by 40%, only the theme with the highest score is kept.
Each selected theme is equally weighted. Within themes, companies are weighted proportionally to their weight in the underlying theme. If a company appears in multiple themes, its weight is the sum of its individual weights across those themes. A single-stock weight cap of 8% is applied, with any excess redistributed back to the corresponding themes on a pro-rata basis.
Quarterly March, June, September, and December.
For more information about the VettaFi Thematic Rotation Quality Momentum Index (TRQM), click here. Our Thematic Rotation index approach can be applied using multiple factor inputs and across different sizes and investment universes.
Thematic investing has become a popular way for investors to get targeted exposure to specific investment themes, market trends, and values. Thematics can provide exposure to unique opportunities not captured by traditional sectors or allocations. But what are the characteristics that make for a good investment theme?
We have covered this topic in the past in our paper Investing in Thematics, but to summarize here:
Trend, not a fad — A good theme is a long-term, durable trend with far-reaching disruptive implications, not a transient fad. Simply put, today’s theme is tomorrow’s sector. A good way to distinguish an investment theme from a fad is that it has economic underpinnings supporting its investment thesis. NFTs and SPACs are two recent ETF investment themes that failed to succeed for that reason.
Megatrends — Some themes are so disruptive and far-reaching in their impact that they qualify as “megatrends.” Megatrends are long-term, secular trends with a global scale, such as climate change, demographic shifts, digitalization, decentralized finance, and, most recently, artificial intelligence.
Underlying regulatory support — When thematic disruption and government regulation align, it can help propel an investment theme.
Investable themes — Often a theme is so nascent that it is not yet investable as there are too few companies with “pure-play” exposure. Investors need to ask themselves, are these companies really a good proxy for this investment theme? Do these companies derive meaningful revenue exposure from the theme, and/or are they dominant players?
Exponential growth — Linear thinking often underestimates the parabolic growth potential of exponential, transformative change. Think about the recent inflection point in artificial intelligence created by the generative AI moment and the subsequent “hockey stick” pattern of surging growth and investment.
Timing - One of the key challenges of thematic investing is picking the right theme at the right time. Despite their long-term potential, investment themes, like stocks themselves, often experience pullbacks or setbacks and are not on a straight upward trajectory.
Selection/Allocation decision — Another challenge for thematic investors is which themes to select and how much to allocate to them as investments. And what is the appropriate percentage allocation to thematics in general?
Few “pure play” companies — As mentioned, with nascent themes, it is often difficult to get “pure-play” exposure from publicly traded companies without sacrificing diversification. There may only be a handful of public companies actually deriving meaningful revenue from a theme.
Overlapping exposure — A company such as Nvidia is involved in many important themes, from artificial intelligence to video gaming to autonomous vehicles and robotics. As a result, investors investing in multiple themes can easily become overexposed to specific companies.
Trading and tax considerations — Even if you get the timing right on a theme, trading is often constrained due to capital gains and other tax considerations.
The VettaFi Index team has come up with an index solution that solves many of the challenges associated with thematic investing.
Factor-based timing — Each quarter, the index selects the top themes based on a combination of aggregate quality and momentum scores to form an equal-weighted thematic index portfolio.
Turn-key thematic solution — Our index approach solves for “where do thematics fit into your portfolio.” Rather than leaving it to the investor to select the “best theme” on a timely basis, theme selection and weighting allocation are determined cross-sectionally, based on systematic, definable investment factors for the aggregate theme. The end result is a turn-key thematic solution.
Allows for pure-play exposure to nascent and sub-themes — Product issuers often face delays getting new themes to market. With our index approach, nascent themes (such as quantum computing) and sub-themes (like humanoid robots) can be included on a more timely basis, even if they do not yet meet the diversification requirements for an ETF index.
Overlapping exposure adjustment — If a company appears in multiple themes, its weight is the sum of its individual weights across those themes. A single-stock weight cap of 8% is applied to avoid overconcentration in any particular company.
Solves for trading and tax constraints — Our multi-thematic index rotation solution solves for trading and tax implication constraints.
The VettaFi Thematic Rotation family of indexes utilizes a systematic approach designed to provide tactical rotation to relevant themes. This strategy aims to address the non-linear and dynamic nature of innovation in thematic investing, providing investors with timely exposure to investment themes.
The first live example of this index approach is the VettaFi Thematic Rotation Quality Momentum Index (TRQM). The Index is reconstituted quarterly and composed of VettaFi’s top themes, as measured by momentum and quality, from VettaFi’s theme universe. The selected themes are equally weighted to form a thematic index portfolio composed of the current highest-rated themes.
Constituents of portfolios that represent themes in VettaFi’s theme universe. The Universe is composed of themes that are VettaFi index or sub-index themes. The Index Committee is responsible for making decisions on theme inclusion when there are questions regarding representation or eligibility.
Each theme receives a composite score, weighted between Momentum (40%) and Quality (60%) components. Themes are ranked by composite score, and selected in descending order until at least 7 themes and 125 companies are represented. When two themes have common ICE sub-industries that overlap by 40%, only the theme with the highest score is kept.
Each selected theme is equally weighted. Within themes, companies are weighted proportionally to their weight in the underlying theme. If a company appears in multiple themes, its weight is the sum of its individual weights across those themes. A single-stock weight cap of 8% is applied, with any excess redistributed back to the corresponding themes on a pro-rata basis.
Quarterly March, June, September, and December.
For more information about the VettaFi Thematic Rotation Quality Momentum Index (TRQM), click here. Our Thematic Rotation index approach can be applied using multiple factor inputs and across different sizes and investment universes.
