Thematic investing has gained prominence in recent years as an alternative approach to traditional investment strategies. This method of investing revolves around identifying, understanding and capitalizing on long-term societal and economic trends – typically macroeconomic ones.

Investors, instead of solely focusing on individual companies or industries, build portfolios around overarching themes or macro trends, aiming to profit from the potential growth and impact of these themes on the global economy.

These themes can encompass a wide range of sectors and industries: from technology and health care to environmental sustainability and demographic shifts.

Start by thinking about the years 2020–2023. Think about big, large meta-events that were happening that you could have (and probably wish you had) invested in due to global or national events. That’s the thought process around thematic investing.

The benefits of thematic investing

Why is thematic investing popular? Let’s take a look at some of its benefits.

Alignment with megatrends

Thematic investing enables investors to align their portfolios with the major forces shaping our world. Megatrends such as technological innovation, climate change and demographic shifts can drive long-term growth and provide a resilient foundation for investment strategies.

Long-term growth potential

By focusing on themes with long-term growth potential, thematic investors seek to capture the compounding effect over time. They position themselves to benefit from trends that are expected to persist or intensify in the coming years.

Innovation and disruption

Many thematic investments are centered around innovation and disruptive technologies. Investing in these themes can provide opportunities to participate in the growth of companies at the forefront of change.

Impactful investing

Thematic investing often aligns with investors’ personal values and societal objectives. For instance, investing in themes like clean energy and sustainability allows investors to contribute to environmental and social goals while pursuing financial returns.

Challenges in thematic investing

While thematic investing has its merits, it also comes with its share of challenges and considerations, and it’s important to be aware of these.

Volatility and risk

Thematic investing can be subject to significant volatility, especially when themes are highly dependent on rapidly changing technologies or market dynamics. Investors must be prepared for fluctuations in their portfolio values.

Lack of historical data

Some thematic investments are relatively new, making it challenging to rely on historical performance data. Investors may need to base their decisions on forward-looking projections and potential future developments.

Concentration risk

Focusing too heavily on a single theme or a narrow set of themes can expose investors to concentration risk. A downturn in the theme’s prospects could have a substantial negative impact on their portfolios.

Market timing

Thematic investing requires a degree of market timing and an understanding of when a theme is in its growth phase. Entering too early or too late can affect returns.

When everyone is telling you what the hot share is, the timing to buy that share has probably passed and now it is time to look for the next theme on the horizon.

Regulatory and policy changes

Themes can be influenced by government regulations and policy changes. For example, healthcare themes may be heavily influenced by changes in healthcare legislation.

One example goes back to the COVID-19 pandemic. Regulatory factors and the eventual government-mandated lockdowns had a huge effect on global markets. Some shares profited greatly and some companies went bankrupt. So thinking through regulatory and policy changes cannot be overstated.

At the end of the day, you might be engaging in thematic investing without really thinking about it if you are trying to make active share buying choices based on the news of the day. But to determine whether you want to be a more active thematic investor, you’ll need to decide how up-to-date you want to be.

A great thematic investor follows trends closely, forecasts how long a trend will last and takes action on that information.

If you are naturally inclined to make lots of moves in your portfolio and stay up-to-date on megatrends, this might be a natural fit for you. If you want to set up your portfolio to basically run itself while you run your hectic life, then it probably isn’t.

Edited extract from The Quick Start Guide to Investing: Learn How to Invest Simpler, Smarter & Sooner by Glen James and Nick Bradley (Wiley). Available at all leading retailers.