ETFs (Exchange Traded Funds) comprising of a basket of securities that jointly have some exposure to a certain investing story are called Thematic ETFs. It is a fast-growing sector of investing. Such securities can give great well-diversified value, but there’s often a lot of work to be done before buying it. Not all of them are what they are told to be. In this post I present some of the recently most discussed thematic ETF stories.
A growing trend
Thematic ETFs are the darlings of Wall Street recently. Many of such securities have gained enormous amounts of assets in the recent years. According to GlobalX, a NYC-based ETF provider, AUM (Assets Under Management) of thematic ETFs industry rose as much as 65% QoQ in 2Q20. And yet the trend is possibly only looking to speed up in the future from what the financial press reports. There are some undeniable advantages of such instruments, which add to their appeal. First, it’s an easy way of playing a certain growing theme in a diversified way. This is especially interesting for retail investors without much professional knowledge and little capacity of analysing stocks one by one. Second, such ETFs (as most ETFs) are cheaper than just buying an actively managed fund. Fees differ of course (more on this below), but as a rule it’s a cheaper way of buying a certain investment story than just a fee to an active manager. Third, by playing a portfolio of ETFs one can adjust it to his own views by buying a specific thematic ETF. An example of such action would be owning a wide health care market index passive fund like Health Care Select Sector SPDR Fund (XLV) and adding exposure to oncology sector by buying an ETF that offers overwight exposure to this subsector of healthcare.
The hottest themes
What’s hottest is usually what is currently on people’s minds as to where and how the world develops or will develop in the future. This is a general rule, but applies also to the financial industry. That’s why ETFs providers are constantly chasing to present the best possible products that a XXI century Robinhood, Millennial and Gen-Z type of investor would want. The world is changing at a pace with no precedence in history and the consequences are often very serious to the societies, environtment and the way we all live. Hence people want to incorporate these changes into their investing practices.
There’s already been numerous trials to build ETFs giving exposure to some strangest themes like Bitcoin or cannabis for instance. Most of them, thus far, have been rejected by the SEC (Securities and Exchange Commission) for concerns around possible fraud, manipulation and ethical reasons.
But these’s also a flurry of new themactic ETFs that are not subject to such scrutiny by the regulators and express the investors’ need of finding the biggest driving themes in the investing world these days. The main focus is mainly on new-era technologies (Artificial Inteligence, cloud computing, fintech, social media, etc.), environmental protection issues, healthcare’s hottest issues (oncology, etc.) or even civil rights. Thematic ETFs can also be plays like high or low volatility or currency hedges. There’s obviously a very long list of thematic ETFs, but there’s no sense for you to go through all of them. Below is a list of some of the recently most talked-about thematic ETFs that I find worth noting:
|Name||Ticker||Theme||AUM (as of 10th Aug 2020)||Total Expense Ratio (TER)||Security type||No. of holdings|
|Global X Cloud Computing ETF Global X Cloud Computing||CLOU||cloud computing||USD1.04bn||0.68%||equity||38|
|Global X Robotics & Artificial Intelligence ETF||BOTZ||robotics and AI||USD1.64bn||0.68%||equity||37|
|Impact Shares NAACP Minority Empowerment ETF||NACP||racial and ethnic diversity||USD7m||0.76%||equity||174|
|WisdomTree Cloud Computing Fund||WCLD||cloud copmuting||USD656m||0.45%||equity||52|
|First Trust NASDAQ Cybersecurity ETF||CIBR||cybersecurity||USD2.1bn||0.6%||equity||44|
|ARK Genomic Revolution ETF (actively managed)||ARKG||many sectors connected with genomics||USD1.72bn||0.75%||equity||44|
|iShares Global Clean Energy ET||ICLN||clean energy||USD1.06bn||0.46%||equity||36|
|IQ S&P High Yield Low Volatility Bond ETF||HYLV||low volatility High Yield bonds||USD110m||0.4%||bond||481|
|Direxion Work From Home ETF||WFH||remote work||USD78m||0.45%||equity||40|
ESG – the new megatrend
One of the biggest trends in thematic investing is the ESG megatrend. the CFA Institute defines ESG as:
“ESG stands for Environmental, Social, and Governance. Investors are increasingly applying these non-financial factors as part of their analysis process to identify material risks and growth opportunities. ESG metrics are not commonly part of mandatory financial reporting, though companies are increasingly making disclosures in their annual report or in a standalone sustainability report. Numerous institutions, such as the Sustainable Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), and CDP are working to form standards and define materiality to facilitate incorporation of these factors into the investment process.”
ESG is becoming the very core of discussions for the whole global financial markets community. And not only. Even the governments and politicians start treating ESG as a crutial issue. The 2020 World Economic forum in Davos took ESG at center stage even.
How to chose wisely
As with every financial instrument it is extremely important to do your homework before buying it, whatever your banker or advisor tells you. Of course most people who are not professionals will have troubles understanding all the peculiarities of investing in such products. Still, maximum possible effort must be done before the purchase is made to avoid bad decisionmaking. If you follow a couple of simple rules, you increase the chances of your thematic ETF investment not being a mistake in the long run.
Most obvious things to check are of course: costs (a Total Expense Ratio for an equity ETF holding passively a basket of names with a yearly fee above 1% should from the start turn on a red light in your head), the issuer (check who issues the ETF is, compare the company’s standings where your can, be it internet or friend interested in ETF investing), leverage (some ETFs are based not on underlying assets, but on derivatives (options, futures, swaps) replicating them – this substantially increases the risk profile of a product), currency (check if your fund is hedged against currency fluctuations), liquidity (adjust your exposure to the fund’s AUM abd daily volumes), bid/ask spreads (these can sometimes be wide enough to eat a substantial portion of your potential profits).
Apart from all the above basics, it is also good to follow a general rule, which some call the “trinity” approach. It consists of 3 basis questions you have to ask yourself before you buy a certain thematic ETF:
1. Is the theme a winner? The ETF you’re buying needs to really be a one looking to play a long-term winning story, which every person can assess as a one that has a bright future ahead. These are usually trends called secular, cyclical or structural – to express their character.
2. Does this ETF capture exposure to the theme appropriately? Check the underlying securities. Do not buy a nice and catchy ticker! At best go one by one through the major 20 biggest-weighing names in your future investment and try to dig as deep as you can into whether these securities really give exposure to the major theme you’re looking for. The investment space is full of catchy-ticker ETFs that turned out to be something totally different than what they seemed to be, be it for the bad choice of their issuer or any other.
3. How much potential does the theme still have? Even best securities can be a bad purchase, if you’re the last in queue to buy them. Before you make your investment try to assess what the market already knows about the theme, how much press coverage there has been about it, what are the general valuation characteristics for the underlying securities at the moment, etc. Remember that the market is a hell of a forward-looking beast and try to avoid a situation of buying an overvalued theme.
ICLN – an example of a thematic ETF
Now I wanted to present to you in short a good example of a thematic play. The iShares Global Clean Energy ET (ICLN) falls clearly under the ESG megatrend (via the “E” part of it). The ETF represents the fast-growing clean energy space, via exposure to a portfolio of geographically diversified mid-cap utitlity, energy, industrial and technology stocks. Its costs are acceptable (0.46% TER). Its issuer is iShares, one of the world’s biggest providers of ETFs owned by BlackRock. It has no leverage and is covered by holdings in the underlying 30-40 stocks within the ETF. It has ample liquidity (and big AUM, making it safe and effective in trading it. Bid/ask spread is 0.01USD – very low. It is not currency hedged (something to be kept in mid by investors).
Here is a list of top 10 constituents of ICLN:
Geographically ICLN looks like this:
The Trinity approach for ICLN:
Is the theme a winner? Clearly clean energy if one of the the most promising trends of the investing world going forward.
Does this ETF capture exposure to the theme appropriately? Yes, 30-40 names is a basket giving enough diversification, both industry-wise and geographic. Most names in the ETF can be called leaders of their sectors.
How much potential does the theme still have? Although the clean energy theme has been a growing concern for over a decade now, its only now that (a) the social and political understanding of the climate changes and (b) the technologies available are at a point, which guarrantees the search for clean energy sources to be a top priority trend that will also be capable of bringing value added for shareholders of such companies or ETFs. Average P/E ratio for ICLN is 25x (not overly high for a growth exposure ETF) and next 5 years average EPS growth is close to 20%.
I hope this post has shed some light for you on the issue of thematic ETF investing. I invite you to share your thoughts and comments on this issue.
Disclaimers: None of the ideas, views and thoughts presented here shall ever be taken as a recommendation to buy or sell stocks,bonds,FX,commodities or any other financial instruments as stated in REGULATION (EU) No 596/2014 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 16 April 2014 on market abuse (market abuse regulation) and repealing Directive 2003/6/EC of the European Parliament and of the Council and Commission Directives 2003/124/EC, 2003/125/EC and 2004/72/EC or the Regulation of the Polish Minister of Finance of 19 October 2005 on information constituting recommendations regarding financial instruments, their issuers or exhibitors (Journal of Laws of 2005, No. 206, item 1715) or the Polish Act of 10 February 2017 amending the act on trading in financial instruments and some other acts. The article is for educational reasons and purely presents private views of the author, thus the author shall not be claimed eligibile for any losses of a third party resulting from trading activities based upon this article. The author uses his best knowledge and data from sources believed to be reliable, but makes no representations as to the accuracy of the data.Full Disclaimers&Liability Limitations page.