Thematic ETFs: Hidden Risks Experts Won’t Tell You

Thematic ETFs are sold as your golden ticket to the future, a way to bet on world-changing ideas like AI, genomics, or clean energy. The marketing is slick, promising you a front-row seat to explosive growth. But what the glossy brochures don't tell you is that most of these funds are built on hype, carry hidden risks, and often arrive just in time for you to buy at the top. The game has changed, and the themes that worked yesterday are not the ones winning today.

Insights

• Thematic investing in 2025 is shifting from pure tech to tangible assets, with major trends including AI infrastructure, defense, global infrastructure development, and regulated digital assets.
• The rise of actively managed thematic ETFs is a significant trend, offering fund managers flexibility but often at a higher cost to investors.
• Regulatory scrutiny is tightening. The SEC's "Names Rule" now mandates that funds invest at least 80% of their assets in securities matching their thematic name, cracking down on "theme washing."
• Key risks are not just volatility but also high fees, poor construction, and liquidation risk. Many funds with low assets under management (AUM) are at risk of closing, forcing you to sell at a bad time.
• Due diligence is paramount. You must analyze a theme's long-term viability, the fund's specific holdings, its expense ratio, and its AUM—now recommended to be over $150 million for stability.

What Exactly Is a Thematic ETF?

A thematic ETF is a fund designed to give you exposure to a very specific, forward-looking trend. Unlike a traditional ETF that might track a broad index like the S&P 500, a thematic fund bets on a single concept. Think of themes like artificial intelligence, cybersecurity, or U.S. infrastructure.

For example, a robotics-focused ETF won't just buy tech stocks. It will hold companies across manufacturing, logistics, and healthcare—any firm that is a key player in the automation revolution. This curated approach lets you make a targeted bet on where you believe the world is heading.

But this targeted approach is a double-edged sword. It concentrates both opportunity and risk.

Thematic vs. Sector ETFs: A Critical Distinction

It's important to distinguish these funds from their simpler cousins, sector ETFs. A sector fund, like one for financials or healthcare, holds a wide basket of companies within a single, formally defined industry.

A thematic ETF, on the other hand, is a conceptual portfolio. It pulls companies from many different sectors that are all connected to one big idea. A cybersecurity ETF might hold software companies, network hardware firms, and consulting services. These companies span different industries but are united by the theme.

This distinction directly affects your portfolio's diversification and risk profile. Sector funds spread risk across an entire industry; thematic funds concentrate it on a single, often unproven, idea.

Major Thematic Battlegrounds of 2025

The themes grabbing headlines and assets are constantly shifting. While yesterday's darlings focused on speculative tech, today's winners are often tied to more tangible, real-world needs. Here's where the money is flowing now.

AI & Tech Infrastructure: The focus has moved beyond flashy software to the backbone of the digital world. This includes companies building data centers, manufacturing semiconductors, and providing the physical hardware that powers AI.

Defense & Geopolitics: A fragmented world has pushed national security and aerospace & defense to the forefront. These are no longer niche plays but central themes driven by global instability.

Infrastructure Development: With government initiatives like the U.S. Infrastructure Investment and Jobs Act, funds focused on construction, engineering, and materials are gaining serious traction. This is a bet on the rebuilding of America.

Healthcare Innovation: Beyond broad healthcare, investors are targeting specific breakthroughs in areas like genomics, robotic surgery, and GLP-1 weight-loss drugs, which have massive market potential.

Digital Assets: With the approval of spot Bitcoin ETFs, regulated digital assets have entered the mainstream. These funds offer a way to gain exposure to cryptocurrencies without the complexities of direct ownership.

The Rise of Active Management: A growing number of thematic ETFs are actively managed, meaning a portfolio manager is making the buy and sell decisions instead of passively tracking an index. This is a major shift in the ETF world.

"Active ETFs are quickly becoming the fastest-growing category in the ETF market."

Christopher Murphy Head of ETF Specialists, T. Rowe Price

The Hidden Risks They Don’t Want You to See

Thematic ETFs are marketed with promises of high growth, but the potential for high losses is just as real. You need to go in with your eyes wide open to the risks.

Hype Cycle Casualties: These funds often launch or become popular after a theme has already seen massive gains. This lures investors into buying at the peak of what's known as the Gartner Hype Cycle—a pattern of inflated expectations followed by a crash. You risk becoming exit liquidity for early investors.

Extreme Volatility: Because these funds are so narrowly focused, they can swing wildly. If a few key companies in the fund perform poorly, the entire ETF can get hammered. There is no broad market to cushion the blow.

"Theme Washing" and Regulatory Crackdowns: For years, fund providers could slap a trendy name on an ETF without its holdings truly matching the theme. The SEC's updated "Names Rule" now requires 80% of a fund's assets to align with its name, but you still need to look under the hood and verify the holdings yourself.

Theme Death: Some trends just don't pan out. A promising technology can become obsolete or fail to gain commercial traction. Your brilliant idea for a "metaverse" fund in 2021 looks a lot less brilliant today. Not every story has a happy ending.

Liquidation Risk: This is the risk nobody talks about. If a thematic ETF fails to attract enough money, the provider will simply shut it down. A fund with low assets under management (AUM)—generally under $150 million today—is a prime candidate for closure. This can force you to sell at a loss and create an unexpected tax bill.

High Costs: Thematic ETFs almost always have a higher expense ratio (ER), which is the annual fee you pay. While a simple S&P 500 ETF might cost you 0.03%, a thematic fund can easily charge 0.75% or more. Those fees are a guaranteed drag on your returns, year after year.

Analysis

What we're seeing is a clear maturation of the thematic landscape. The initial gold rush was about abstract, often unprofitable, ideas. The new era is about tangible results and real-world application. The shift toward infrastructure, defense, and the physical components of AI shows that investors are demanding more than just a good story. They want to see steel, silicon, and cash flow.

This shift is happening alongside two other powerful forces: regulation and active management. The SEC's crackdown on "theme washing" is a direct response to the wild west of the last few years. It forces accountability but also means you have to pay even closer attention to how a fund defines its theme to meet the 80% rule. Is it pure-play companies, or is the definition stretched to include enablers and beneficiaries?

At the same time, the surge in active thematic ETFs is an admission by the industry that a static, index-based approach may not work for capturing fast-moving trends. An active manager can theoretically pivot faster than an index. But this also introduces manager risk—you're not just betting on the theme, you're betting on a specific person or team to get it right. And you're paying them handsomely for the privilege, whether they succeed or not.

These forces combined—a focus on tangible assets, stricter regulation, and the rise of active management—create a much more complex battlefield for investors. Success is no longer about just picking a hot trend; it's about dissecting fund construction, understanding regulatory nuances, and deciding if you trust a manager's strategy more than a passive index.

Final Thoughts

So, where does this leave you? Thematic ETFs are not inherently bad. They are specialized tools for expressing a specific market view. The mistake is treating them like the core of your portfolio. They are tactical weapons, not the foundation of your financial fortress. Most professionals I know treat them as such, allocating a small, single-digit percentage of a portfolio to these kinds of targeted bets.

Before you even consider investing, you must do the work. Assess if a theme has genuine, long-term staying power or if it's just a fleeting fad. Dig into the fund's holdings—don't just read the top ten. Check its AUM to gauge its risk of closure. And compare its expense ratio to its peers. Is the cost justified?

The allure of capturing the "next big thing" is powerful. But building lasting wealth isn't about hitting home runs on speculative trends. It's about consistent, disciplined investing in solid, well-understood assets. As the head of ETFs at a major firm once said, the real money is made elsewhere.

"The next $10 trillion in ETF assets is going to come from the core — the ‘meat and potatoes’ part of portfolios."

Dave Abner Head of Global ETFs and Funds, Northern Trust

Use thematic ETFs sparingly, if at all. Understand the game you're playing and the risks you're taking. Build your wealth on a rock-solid core, and use these funds as the speculative satellite positions they were designed to be.

Did You Know?

As of early 2025, the global market for thematic ETFs has grown to approximately $400 billion in assets under management. However, a significant number of these funds remain below the $150 million AUM threshold that many analysts consider a minimum for long-term viability, highlighting the persistent risk of fund closures.