Thematic and sector ETFs: Risks and rewards
One of the great things about exchange traded funds (ETFs) is that investors can now gain exposure to almost any investment idea imaginable.
Artificial intelligence. Biotechnology. Cybersecurity. Space exploration. Gold. Robotics.
That can make investing more interesting. It can also make it riskier.
Not all ETFs offer the same level of diversification. There is a big difference between an ETF holding hundreds or thousands of companies across multiple countries and industries, and one concentrated in a particular sector, theme or handful of companies.
That targeted exposure can create opportunities, but it can also increase concentration and volatility.
That doesn't mean thematic or sector ETFs don't have a role to play. But for most investors, they are better suited as satellite investments around a diversified core.
When diversification isn't quite so diversified
A useful recent example is the Global X Space Tech ETF (ASX: MOON).
MOON began trading on the ASX on 11 June, one day before SpaceX was listed. SpaceX was added to the portfolio shortly afterwards and made up about 27% of the ETF as at 2 September.
SpaceX initially surged after listing before suffering a substantial fall from its post-IPO highs. That volatility was reflected in MOON, which was down about 31% from inception to 1 September.
SpaceX isn't solely responsible for MOON's performance, with other space stocks also coming under pressure. But when one volatile company represents more than a quarter of an ETF, its performance can still have a significant effect on the overall portfolio.
That's concentration risk wearing an ETF-shaped hat.
Targeted exposure can work both ways
If SpaceX shows the risks of targeted exposure, biotechnology recently showed the potential upside.
On 19 August, Moderna and Merck announced positive late-stage results for their personalised mRNA cancer vaccine for melanoma. Moderna shares surged as much as 160% following the announcement, Merck jumped 12%, and the broader Nasdaq Biotechnology Index climbed 4.4%, according to Reuters.
Australian ETF investors didn't need to own either company directly to have some exposure to those gains.
The Global X S&P Biotech ETF (ASX: CURE), for example, had around 1.3% invested in Moderna in late July, while the Betashares Global Healthcare Currency Hedged ETF (ASX: DRUG) had 4.2% invested in Merck around the same time.
That's one of the attractions of thematic or sector ETFs. You can gain exposure to an area such as biotechnology without having to predict which company or drug trial will produce the next breakthrough.
The SpaceX and biotechnology examples show how targeted exposure can work both ways. It can boost returns when things go right. It can hurt when they don't.
Build the core first
This is where a core and satellite strategy makes sense.
The core does most of the heavy lifting. It might include Australian and international shares, plus defensive assets such as bonds and cash, depending on your investment timeframe and risk profile.
Satellite investments sit around that core.
Maybe you believe biotechnology has enormous potential. Maybe you're bullish on technology, gold or space exploration. Putting a smaller part of your portfolio into those ideas gives them room to make a difference if you're right, without letting one sector or theme dominate your portfolio.
There's no single correct allocation between core and satellite investments. What matters is recognising that an interesting investment idea isn't the same thing as a diversified investment strategy.
Thematic and sector ETFs can give you targeted exposure to areas of the market you're interested in, without having to pick individual winners.
They can earn a place in your portfolio. They just shouldn't be asked to do the whole job.
Take the next step with InvestSMART
InvestSMART's professionally managed ETF portfolios are designed to help you build a diversified core suited to your investment timeframe and risk profile.
For investors who also want exposure to particular sectors, themes or ideas, InvestSMART Custom lets you combine that professionally managed core with up to five ETFs selected from our approved range.
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Frequently Asked Questions about this Article…
Thematic and sector ETFs are exchange traded funds that focus on a specific idea, industry or theme—think artificial intelligence, biotechnology, cybersecurity, space exploration, gold or robotics. Instead of tracking a broad market index, they hold companies tied to that theme, giving you targeted exposure without having to pick individual stocks.
Broadly diversified ETFs typically hold hundreds or thousands of companies across countries and industries, which lowers single‑company or sector risk. Thematic or sector ETFs are more concentrated—sometimes a handful of companies or a single industry—so they can be more volatile and their performance can be heavily influenced by a few names.
They can be. Targeted exposure increases concentration and volatility, which means gains or losses from a single company or event can have an outsized effect. For example, the Global X Space Tech ETF (ASX: MOON) had SpaceX make up about 27% of the fund and was down roughly 31% from inception to 1 September, illustrating concentration risk.
Yes. Thematic exposure can work both ways. A recent case: on 19 August Moderna and Merck reported positive results for an mRNA cancer vaccine, sending Moderna shares up as much as 160% and Merck up about 12%. Sector ETFs with holdings in those companies—like the Global X S&P Biotech ETF (ASX: CURE) and Betashares Global Healthcare Currency Hedged ETF (ASX: DRUG)—benefited from those moves.
For most investors, thematic and sector ETFs are best used as satellite investments around a diversified core. Let your core (broad Australian and international shares, and defensive assets like bonds or cash depending on your timeframe and risk profile) do the heavy lifting, and allocate a smaller portion to themes you believe in so they can add upside without dominating the portfolio.
A core-and-satellite approach means building a diversified core portfolio that covers broad market exposure and stability, then adding smaller satellite positions in thematic or sector ETFs to capture specific ideas or potential growth areas. This balances diversification with the ability to express convictions without letting one theme control your entire portfolio.
Thematic and sector ETFs give you exposure to an area of the market without having to predict which company will deliver the next breakthrough. For example, investors could gain biotech exposure through ETFs such as CURE or healthcare exposure through DRUG, rather than buying individual stocks like Moderna or Merck directly.
Yes. InvestSMART offers professionally managed ETF portfolios designed to build a diversified core matched to your timeframe and risk profile. For investors who want targeted exposure, InvestSMART Custom lets you combine that professionally managed core with up to five ETFs selected from their approved range.
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