An Anatomy of Thematic Investing

Performance chasing with a narrative

May 2022. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Thematic investing is combining a good story with positive performance
  • Unfortunately, themes often collapse when the story does not play out as expected
  • Or when valuations have become excessive due to investors’ enthusiasm

INTRODUCTION

The ETF database and news website ETF.com categorizes Cathie Wood’s ARK Innovation ETF (ARKK) as the largest thematic ETF in its database. Although ARKK is down approximately 60% over the last 12 months, compared to +1% for the Nasdaq 100, the ETF still manages almost $10 billion of assets.

However, ARKK does not really fit the definition of thematic investing, which is a bet on certain structural trends rather than individual companies or sectors. A thematic portfolio should consist of one or several themes that are created from as many stocks as possible, ideally equal-weighted, in order to avoid firm-specific risks.

In contrast, ARKK’s top 10 holdings constitute 60% of the ETF’s portfolio, which represents simply a concentrated actively managed portfolio comprised of growth stocks.

Given the poor long-term track record of active managers, the odds of ARKK fully recovering and significantly outperforming the Nasdaq are fairly slim. Although ARK Investments manages several ETFs that ensure some business longevity, it will be interesting to see if the firm will soon be forgotten, or manages to revive its tarnished reputation. The quick rises and equally quick falls in fame are something where highly active and thematic investors overlap (read Thematic Investing: Thematically Wrong?).

In this research note, we will analyze the birth, life, and death of a theme.

CANNABIS ETFS

We select cannabis stocks as a theme as that was one of the major ones over the last five years. Specifically, we choose ETFs that focus on cannabis stocks and are traded in the US. This is a universe of nine ETFs that cumulatively manage slightly above $2 billion of assets.

One of the hallmarks of thematic investing is that the products are expensive. The management fees of cannabis ETFs in the US range from 0.42% to 0.92%, compar