Thematic ETFs - Fad or Fab?

The number of thematic ETFs has exploded in recent years. But are they more than just another investing craze?

There are close to 2,300 thematic ETFs currently available 1, offered by major fund companies like BlackRock and Vanguard, as well as smaller fund managers. You can now invest in specific sub-sectors, market segments and demographics, or even align your portfolio with your moral values.

Are these themed ETFs simply a marketing tactic to entice investors with the latest shiny object? Or can they have legitimately useful role in investors' portfolios?

Why should you care about thematic ETFs?

Thematic ETFs allow investors to buy shares in a range of companies involved in specific niches or themes like robotics, artificial intelligence, big data, genomics, or organic products. Compared to seeking exposure to a niche or theme by owning a small number of individual stocks, thematic ETFs allow you to own a whole basket of companies. Depending on the scope of the theme, your ETF could even hold companies from a wide range of industries.

Proponents of thematic ETFs, however, are keen to clarify the difference between themes and fads.

"Themes tend to be considered alpha generators and shouldn't be confused with fads," says Raj Lala, President and CEO at Evolve ETFs, which offers a number of thematic ETFs. "Thematic investing should serve long-term investment trends. In many cases, there is a place within an investor portfolio for a thematic ETF with a solid investment thesis."

Once you have an established, core portfolio, thematic ETFs can be a way to provide exposure to specific themes that you believe have potential for growth.

Something for everyone: Investing in beliefs, causes and hobbies

Thematic ETFs also allow investors to align their portfolio with their moral beliefs, passions or causes they care about.

For example, Global X's Catholic Values ETF (CATH) caters to Christian investors who wish to invest in line with their faith. In Europe, Muslim investors are the market for Blackrock's iShares MSCI World Islamic UCITS ETF (ISWD).

For those who want to consider the broader impact of their investments, there are a number of interesting thematic ETFs in the Responsible Investment category. Global X's Conscious Companies ETF (KRMA), for example, screens-in companies committed to creating positive outcomes for a variety of stakeholders, including employees, customers, communities, suppliers, and stock and debt holders.

Other ETFs align with causes, like the Workplace Equality Portfolio ETF, which holds stocks only in companies that support LGBT equality in the workplace.

Some cause-based ETFs offer a compelling risk/reward story. For example, gender diversity mandates, such as the Evolve North American Gender Diversity Index ETF, which invest in companies with high gender diversity in senior management, point to several recent studies suggesting that companies with a higher proportion of female leaders are more profitable than those with predominantly male executive teams.2

However, funds catering to ethical or religious interests are only a subset of a growing line up of thematic ETFs: another subset simply gives investors the ability to buy shares in line with their personal interests.

Whiskey connoisseurs, for example, can own Spirited Funds/ETFMG's Whiskey & Spirits ETF, and gambling fans can bet on the industry giving them big returns with the VanEck Vectors Gaming ETF.

Other ETFs reflect growing trends that transcend specific industry sectors. For example, the Global X Robotics & Artificial Intelligence ETF contains a wide variety of companies involved in developing AI and robotics technology; its holdings span 12 industries from eight countries.

The ups and downs of thematic ETFs

Many of these ETFs have up to 40 companies represented, from several countries. So if you want exposure to a theme, you can avoid the risk of investing in just one stock and also save the time that would be spent in researching individual firms.

Keep in mind that some thematic ETFs are designed for day traders and are only suited to sophisticated investors who actively manage their investments.3

On the down side, management fees can be higher than for typical ETFs, with expense ratios above 1% at the top end.

Some of the more niche ETFs are small in terms of the value of their assets under management. As with any ETF or mutual fund, that's something to watch for because smaller funds may ultimately not be financially viable. For example, the Restaurant ETF (BITE) opened in 2015, but investors didn't find it tasty. The fund closed just over a year later after attracting less than $1.5 million.4

How they fit in your portfolio

The right thematic ETFs can help you jump on board emerging sub-sectors. They offer a focus on a specific theme with less risk than buying single stocks.

However, given their narrow focus, thematic ETFs are likely to be more volatile than more broadly diversified ETFs. For this reason, they shouldn't be considered part of your core portfolio.

What to consider when evaluating thematic ETFs

Thematic ETFs can bring you exposure to sub-sectors or market segments that you believe are likely to grow. They can also help you invest in companies aligned to your moral or ethical beliefs or your interests.

Before you invest, however, there are a few things to keep in mind.

It is important to have an established, core portfolio before considering niche ETFs.

Traditional ETFs are about tracking market performance at the lowest possible cost. Thematic ETFs are about adding exposure to a niche that has the potential to outperform the markets.

Most thematic ETFs should be considered speculative plays, and for that reason you need to understand and be willing to accept the additional risks before you invest.

 

Please note that any ETFs mentioned in this article are for reference only and are not investment recommendations.

References

  1. Johne, Marjo, "Niche ETFs zero in on macro trends." The Globe and Mail, September 12, 2017. https://www.theglobeandmail.com/globe-investor/globe-advisor/niche-etfs-offer-a-way-to-zero-in-on-macro-trends/article34651284/ (Accessed January 2, 2018)
  2. Zarya, Valentina, "New Proof That More Female Bosses Equals Higher Profits." Fortune, February 8, 2016. http://fortune.com/2016/02/08/women-leadership-profits/ (Accessed January 3, 2018)
  3. Direxion "Daily Semiconductor Bull 3x Shares." http://www.direxioninvestments.com/products/direxion-daily-semiconductor-bull-3x-etf (Accessed January 3, 2018)
  4. Thompson, Jennifer, "Fancy investing in a theme? There's an ETF for that." The Financial Times, September 7, 2017. https://www.ft.com/content/45637d62-7767-11e7-a3e8-60495fe6ca71 (Accessed January 2, 2018)