Why Buying Several Thematic ETFs May Not Diversify Your Portfolio
ETFs with different theme names can hold the same stocks and industry risks. Calculate top-holding weights and overlapping exposures, then check how much revenue actually relates to the theme.
Assess thematic ETF diversification by actual holdings and risk factors rather than product count. Different themes can rely heavily on the same large technology stocks or investment cycle. Start by multiplying each ETF's account weight by its individual stock weights, then add the exposures across your account.
Look beyond the theme name to actual revenue
Overlapping themes such as artificial intelligence, automation, and digital transformation often include the same companies. The degree of thematic focus varies with whether the index selects by revenue share, relevance in business descriptions, or specialist assessment. A company operating a particular business is different from most of its value coming from that business. Verify the methodology's inclusion rules, then check the scale of the relevant business in top holdings' disclosures. Even strong thematic relevance leaves a separate question of whether the price already reflects high expectations.
Calculate top holdings and common risks together
The combined weight of the ten largest holdings is a quick concentration measure, but different company names do not mean every risk is diversified. Component suppliers and equipment makers reliant on the same customer's capital spending can suffer the same demand shock despite being different stocks. Also group exposures by country, currency, interest-rate sensitivity, and commodity dependence. To determine whether one factor can shake the entire account, combine all ETF holdings and classify them again by sector and risk factor.
Consider biases from inclusion timing and scheduled turnover
Historical simulations for a thematic index created after interest in the theme grew may include periods before actual management began. Separate pre-launch index performance from ETF performance after listing, and check whether costs are included. It also matters when companies are removed if their relevance to the theme changes. Consider the possibility of unfavorable trading conditions or continued outflows as fashions change. Long-term growth in a theme and the return earned by an investor paying a particular price are different questions, so write down the investment rationale separately. Before adding a new ETF, calculate its overlap with existing holdings to judge whether it brings additional diversification.
Worked example
Hypothetical example: You allocate 60% of your investment to ETF A and 40% to ETF B, which hold the same company X at weights of 20% and 15%, respectively. Your combined exposure to X is 60% × 20% + 40% × 15% = 18%. All else equal, if X alone falls 30%, its direct contribution to the account's loss is about 5.4%. Actual losses could be larger if other holdings suffer the same shock.
What to check
- Have you converted top holdings into account-level weights?
- Have you checked whether thematic inclusion is based on revenue or qualitative judgment?
- Have you examined overlapping customer, currency, and interest-rate risks?
- Have you distinguished actual live performance from simulated pre-listing performance?
Sources and primary materials
This is educational material about research methods. For an actual company decision, verify the filings and primary sources for the relevant period.