How thematic funds add value to portfolios

Thematic funds attract investors with exciting investment stories and attractive return prospects. Within an equity or multi-asset portfolio, they can also improve efficiency and increase diversification.

Autor: René Nicolodi, Head Equities & Themes

Adding the right thematic funds can spice up a portfolio and generate additional returns. (Image:

In the search for attractive investment ideas, more and more investors are discovering actively managed thematic funds. With good reason, as these vehicles offer an easy way to invest in megatrends that are likely to have a significant impact on humanity and its future development. Examples include global issues such as climate change, digital transformation or, more specifically, the topic of water. The funds invest in companies that have technologies and innovative solutions for the challenges ahead and should benefit disproportionately from the growth of these future trends with their products and services.

Such an investment can be extremely worthwhile. This can be seen, for example, in one of the most popular indices in the water sector, the "S&P Global Water" index, whose total return since 2004 is 634.2 percent according to Bloomberg. Over the same period, the MSCI World Index has achieved a significantly lower increase of just 404.7 percent, while the broad Swiss Performance Index (SPI) has only risen 256.8 percent.

Thematic funds offer more than attractive potential returns. By focusing on selected economic developments and social megatrends, they overcome the traditional boundaries of investment funds. As a result, they offer another advantage: thanks to their special characteristics, they are suitable as an interesting addition to a broad, traditional equity portfolio, thereby expanding the investment universe. At the same time, they provide an additional diversification effect and thus enrich the overall portfolio.

Thematic funds show character

As thematic funds are not based on traditional classifications such as regions and sectors, they often have a lower correlation with other asset classes (see chart below). However, they are not completely independent of their performance. This leads to specific characteristics that certain thematic funds can bring to a portfolio in a targeted manner. One example is cybersecurity: many companies operating in this sector generate their revenue through software-as-a-service (SaaS) models, which result in continuously recurring revenues. As a result, these companies - within a generally cyclical technology sector - are less sensitive to economic changes.

Correlations between leading equity indices and thematic funds: In combination with the SPI, positive effects can be expected across the board. (Source: Zürcher Kantonalbank)

A look at the chart shows that thematic funds, particularly for Swiss investors who traditionally have a high affinity for equities from the SPI universe, are an interesting additional diversification option due to their low correlation with this index. The lowest value of 0.2 - measured against the Global Cybersecurity Index - is achieved in combination with the topic of cyber security. The correlations of the SPI with the indices on big data, infrastructure, renewable energies and health risks are also clearly in the green zone.

But beware: Thematic funds can be subject to major fluctuations at times. For example, if a megatrend, such as artificial intelligence, suddenly becomes the talk of the town, arousing high expectations and attracting corresponding funds – or when it's no longer topical and falls off the agenda at short notice. At the same time, topics change very dynamically over time. Under certain circumstances, today's winners in a theme may be tomorrow's losers. Active management of thematic investments therefore seems particularly important.

Dynamising addition

Within a portfolio, the different characteristics of themes can be used to investors' advantage. The efficient frontier analysis, which compares two portfolios with and without thematic investments, shows that in a global equity portfolio, the efficiency curve shifts upwards with thematic funds, leading to better risk-adjusted returns  (see chart).

Source: Zürcher Kantonalbank

Thematic funds can therefore play an interesting role, especially when they are added to a portfolio as so-called "satellite investments": If the core of a portfolio consists of solid and traditional investments, thematic funds should have a dynamising and diversifying effect on the overall portfolio. If thematic products are added to a core portfolio of traditional investments, the risks of the entire portfolio can be reduced.

In this context, however, it is also clear that the selection and weighting of thematic funds – and even more so the active selection of individual securities within the theme – is of great importance. After all, investors want to use their investments to participate in global upheavals and developments, which in some cases are still in their infancy and are only just gaining momentum. The precise selection of the most promising companies with high growth potential therefore requires even greater expertise, as such trends are not only very dynamic and influenced by regulation, but the values are also sometimes more illiquid and there are greater information asymmetries.

For this reason, active management is particularly important in the area of thematic funds, as the quality of research on the analysis side and specialist portfolio management expertise pay off particularly well here. The same applies if you want to benefit from the additional diversification effects and yield opportunities: Here too, professional advice is recommended, which is concerned about a suitable addition to the portfolio and knows how to skilfully exploit the lower correlation to traditional investments.