The Ultimate Guide to Thematic Indices
Discover everything you need to know about thematic indices, advantages, how they differ from traditional indices,
key considerations for investors, and a step-by-step guide to constructing your own thematic index.
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What is a Thematic Index?
Thematic indices are designed to track companies that are specifically exposed to a particular long-term trend or investment theme, regardless of their geographic location or traditional sector classification.
These themes are often driven by macroeconomic, technological, environmental, or demographic forces and may include:
Artificial Intelligence (AI)
Clean or Renewable Energy
Cybersecurity
Blockchain Technology
Electric Vehicles (EVs)
Space Exploration
These indices are forward-looking, aiming to capture shifts in the global economy rather than simply reflecting current economic conditions.
Differences Between Traditional and Thematic Indices
| Feature | Traditional Indices | Thematic Indices |
|---|---|---|
| Objective | Represent broad markets | Capture specific megatrends |
| Composition | Large, diversified companies | Focused on theme-relevant firms |
| Selection | Market cap, sector, liquidity | Revenue exposure, innovation,relevance |
| Sector Focus | Balanced across economy | Often cross-sector, theme-driven |
| Time Horizon | General performance tracking | Long-term structural growth potential |
Advantages of Thematic Indices
Growth Opportunities:
Thematic indices are designed to capture long-term structural changes driven by disruptive innovation or secular trends that transcend traditional sectors.
By focusing on companies that are pioneers or significant players in transformative areas, thematic indices aim to deliver above-average growth potential as these themes reshape industries and consumer behavior over the coming decades.
Performance:
Historically, some thematic indices have outperformed traditional benchmarks, but often in cycles
For example, clean energy or tech-related indices saw strong outperformance during periods of innovation enthusiasm, but can also underperform when market sentiment shifts or themes fall out of favor.
Unlike broad traditional indices which are designed for stability and diversification, thematic indices are more volatile but potentially higher reward.
Volatility:
With their narrower focus and less diversified holdings, thematic indices carry higher volatility.
Key risks include:
Sector concentration.
Company-specific risks, as small or mid-cap innovators dominate thematic baskets.
Market timing risk, since themes may be speculative and prone to hype cycles.
Thus, while thematic indices offer growth, they often do not replace core holdings but rather complement them in a portfolio.
How to Construct a Thematic Index
1. Index Provider
Specialized index providers such as Index One design, maintain, and calculate thematic indices.
They ensure methodological transparency, periodic rebalancing, and data accuracy.
2. Selection Criteria
Thematic indices rely on both quantitative and qualitative screens to select relevant companies. Criteria typically include:
Market Capitalization: Often include mid and small-cap stocks in addition to large-cap leaders.
Revenue Alignment: Companies must derive a significant percentage of revenue from the core theme.
Business Model Relevance: Assessed via business descriptions, R&D spending, or patent portfolios.
Geographic Scope: May be global or region-specific.
These filters help ensure purity of exposure to the underlying index theme.
3. Weighting Methodologies
Once companies are selected for inclusion in a thematic index, different weighting methodologies are applied to determine how much influence each constituent has on the index's overall performance.
Equal-Weighted: Gives each constituent the same weight.
Market Cap-Weighted: Larger companies have more weight.
Custom Weighting: Weights based on revenue relevance, innovation scores, or growth potential.
Custom weighting allows fine-tuning for thematic intensity and risk balance.
Key Considerations of Thematic Indices
Concentration Risk:
Thematic indices often have:
Fewer holdings than traditional indices
High exposure to a single sector
High exposure to early-stage or unprofitable firms
This leads to limited diversification, increasing portfolio volatility.
Theme Longevity:
Is the theme a lasting megatrend or a temporary market fad?
Durable themes like climate change, demographic shifts, or digital transformation may offer long-term growth.
Speculative themes like meme stocks or short-term tech fads may lose relevance quickly.
Index One Thematic Indices
Index One calculates the following thematic indices:
i1 Magnificent 7: Targets Apple, Microsoft, Amazon, Nvidia, Meta, Tesla, and Alphabet.
i1 US Tech 100: Captures the top 100 U.S. technology firms
i1 BATMMAAN: Sherwood (sherwood.news) coined the term BATMMAAN, representing a group of influential stocks including Broadcom, Apple, Tesla, Microsoft, Meta, Amazon, Alphabet, and NVIDIA.
i1 Verbified Company Index: This index comprises companies whose names have become commonly used verbs.
i1 NUTS: Waverton coined the acronym NUTS that targets Nat Ned, UPM, Technip Energies and Siemens.
i1 GRANOLA: Goldman Sachs has coined a term that includes GSK, Roche, ASML, Nestlé, Novartis, Novo Nordisk, L'Oréal, LVMH, AstraZeneca, SAP, and Sanofi, Europe's leading stock market players.