Thematic Investing: Tomorrow’s Themes, Today

The case for thematic investing

Thematic investing has grown in prominence as a way for investors to align portfolios with the evolving trends shaping the future economy. Over the last 10 years, assets managed in the U.S.-listed thematic funds have grown nearly ten times from $9.7bn in 2014 to $92.7bn in 2024.¹

Themes can be described as topics that are front-of-mind for investors, persist over time, and have demonstrated an ability to drive equity market returns. We define themes as meeting three criteria:

Themes are dynamic. The top themes driving markets are constantly shifting, requiring a timely and scalable approach to identify the most important themes in equity markets today.
Themes impact generally unrelated companies. Capturing thematic alpha² requires anticipating new linkages across stocks. The traditional groupings by sector, industry, or country may overlook the cross-market returns driven by themes.
Themes have the potential to drive meaningful returns. Investors need a framework for evaluating the return potential of themes while seeking to allocate across the strongest opportunity set.

We can begin to understand how themes evolve by assessing the attention they receive using natural language processing (NLP) techniques. By nature, themes create a persistent flow of news. They can be topics that investors are researching, corporate officers are addressing in conference calls, the press is publishing, and government officials are often responding to. Leveraging these text sources, we aim to quantify the flow of information to determine a theme’s relevance and life span.

Take for example the release of ChatGPT in late 2022. We view artificial intelligence as a persistent structural theme that will drive innovation for years to come. However, the launch of this consumer-facing technology led all aspects of the AI value chain—from GPUs and large language models to data centers and power generation—to surge in popularity.³ Figure 1 shows how we measure this with a proprietary attention score which currently exceeds historical highs of “big data”, “clean tech”, and “SPACs,” and is only modestly below “credit defaults” in the Great Financial Crisis (GFC).

We also find that some themes persist while others rapidly decay. Generating consistent returns requires seeking alpha opportunities across the broadest possible range of thematic opportunities. While long-term themes can align a portfolio with transformational change and innovation, many short-term themes can crowd out investor flows and attention—and importantly, may not be directly accessible in an off-the-shelf investment vehicle. The ability to incorporate new thematic ideas into portfolios requires data, technology, and scale to effectively pursue this spectrum.

Thematic rotation: thematic + dynamic

Armed with a deep understanding of themes, our systematic framework used within the iShares U.S. Thematic Rotation Active ETF (THRO) seeks to generate consistent alpha by addressing the unique challenges of thematic investing: How do you identify which themes to invest in? What measures should be used for a theme’s entry and exit point? How should an allocator benchmark thematic returns?

Our process leverages data and technology to monitor how themes develop and interact in real-time, incorporating a breadth of insights to navigate the thematic landscape.

How do you identify themes to invest in?

Our systematic approach starts with collecting vast amounts of data. We analyze over one million financial news articles each year and more than five thousand earnings call transcripts every quarter, as shown in Figure 3. Our models seek to link companies to the potential themes identified. This paints a detailed picture of the current thematic landscape — potentially before the market can piece together evolving trends.

Our analytical capabilities can do more than detect themes—they can identify the most relevant companies tied to each trend. Let’s consider a theme like generative AI, for example. Our model constructs a custom basket using a range of data sources, first including existing sell-side baskets and thematic funds, tracking stocks that brokers and portfolio managers have identified as relevant. These sources tend to consist of first-order exposures and capture a highly concentrated cohort of stocks. For AI, this could include firms that develop AI technology and semiconductor manufacturers who create the hardware necessary for AI model training.

Then, using NLP techniques, we expand the initial cohort to include a broader group of stocks that spans both direct and indirect relationships to the theme, revealing more subtle linkages. We extract keywords from broker research, and search for those keywords across sources such as conference call transcripts and financial news. This text-mining can uncover names not originally captured. For example, we may discover companies cutting costs by enhancing back-office tasks, asset managers investing in the space, or even firms who seem relatively resilient to the technological change given the physical nature of their processes.

What are the entry and exit points?

Part of an alpha-seeking, systematic approach to thematic investing is the consistent and timely analysis of existing themes. This requires the daily evaluation of the return potential of all themes in the investible universe that we’ve identified—something that most investors are not equipped to do on their own.

Proprietary systematic signals may yield dynamic and timely return forecasts that shape the current view of each theme. These signals tend to favor themes with positive investor sentiment and strong stock price performance, while also accounting for factors like over-crowding and over-valuation. We rank themes by combining these insights, as shown in Figure 4. Each signal feeds into the theme’s overall rating, and the aggregated view helps determine how we rotate across themes within a portfolio.

This lays the groundwork for portfolio implementation. To build the thematic rotation portfolio, we use an optimization that incorporates both our alpha forecasts for each individual theme and the interactions, or correlations, across stocks and themes. The resulting portfolio may reflect overweights in the themes where we have greater conviction and underweights in themes where we may forecast less supportive outlooks. Additionally, our implementation is focused on diversification and risk management,⁴ accounting for interactions between themes and transaction costs.

How do you benchmark thematic returns?

With broad US equities as our reference benchmark, our approach to thematic rotation seeks to generate consistent and compelling excess returns above and beyond the market.

As themes such as the pandemic and generative AI have dominated headlines in recent years, it’s no surprise that thematic investing has garnered attention. Our analysis indicates that a dynamic thematic strategy rooted in a systematic framework may enhance portfolio exposure while complementing other investment allocations.

By transforming a wealth of data into valuable insights, a systematic approach offers the potential to capture thematic alpha with precision. Investors can access diversified exposure to a spectrum of timely and transformational themes — making a systematic framework the future of thematic investing, in our view.

¹ BlackRock, as of September 30, 2024. AUM reflects a universe of U.S.-listed thematic funds identified by BlackRock’s Global Business Intelligence. All amounts in USD.
² Alpha is the excess return of a fund relative to the return of a benchmark.
³ Number of CHATGPT users (Nov 2024). Exploding Topics. https://explodingtopics.com/blog/chatgpt-users
⁴ Diversification and asset allocation may not fully protect you from market risk. Risk management cannot fully eliminate the risk of investment loss.

Carefully consider the Funds' investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds' prospectuses or, if available, the summary prospectuses, which may be obtained by visiting the iShares Fund and BlackRock Fund prospectus pages. Read the prospectus carefully before investing.

Investing involves risk, including possible loss of principal.

Funds that concentrate investments in specific industries, sectors, markets or asset classes may underperform or be more volatile than other industries, sectors, markets or asset classes and than the general securities market.

Actively managed funds do not seek to replicate the performance of a specified index, may have higher portfolio turnover, and may charge higher fees than index funds due to increased trading and research expenses.

The Fund's use of derivatives may reduce the Fund's returns and/or increase volatility and subject the Fund to counterparty risk, which is the risk that the other party in the transaction will not fulfill its contractual obligation. The Fund could suffer losses related to its derivative positions because of a possible lack of liquidity in the secondary market and as a result of unanticipated market movements, which losses are potentially unlimited. There can be no assurance that the Fund's hedging transactions will be effective.

Small-capitalization companies may be less stable and more susceptible to adverse developments, and their securities may be more volatile and less liquid than larger capitalization companies.

Securities issued in IPOs have no trading history, and information about the companies may be available for very limited periods. In addition, the prices of securities sold in IPOs may be highly volatile or may decline shortly after the IPO.

There is no guarantee that the classification system used to determine the rotation model or strategy will achieve its intended results. The fund may engage in active and frequent trading of its portfolio securities which may result in higher transaction costs to the fund. The fund is actively managed and does not seek to replicate the performance of a specified index.

This material represents an assessment of the market environment as of the date indicated; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.

The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.

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