Choose wisely with thematic ETFs
Many investors like to invest in big themes, seeking exposure to a range of companies which could benefit from something hot in the market or structural growth in a certain industry, geography or demographic.
Historically investors have achieved this exposure through putting money into certain unit trusts, Oeics and investment trusts. Exchange-traded funds are now providing another avenue for investors, although the range of themes is much more limited.
We would expect this situation to change over time but for now investors in the UK may find the best options for thematic investing to be found among ETFs targeting three categories – technology, the environment and social responsibility.
The ETFs track various indices, each of which containing a basket of stocks related to a specific theme. Many of these stocks will be big, multinational companies with high liquidity and which are in a strong position to take advantage of clear, long-term structural trends.
LARGE NUMBER OF PRODUCT CLOSURES
ETF providers will launch new products to meet demand for different themes, although it is worth noting that their longevity is dependent on attracting sufficient funds from investors and gaining the scale to keep operating. The track record is mixed to say the least.
Thematic ETF closures
Examples of thematic ETFs which have come and gone include ones tracking areas such as:
Industries involved in the whiskey and bourbon economy
The agriculture industry
Companies demerged from bigger entities
A report by Morningstar last year found that almost four in five thematic ETFs launched in Europe before 2012 have now closed, compared with less than half of the more traditional ETFs which track mainstream stock indices such as the FTSE 100 or S&P 500.
In total, 35% of all thematic ETFs launched in Europe have already closed. ‘This means that even if investors select a winning theme, they will be lucky if their chosen ETF survives long enough to profit,’ Morningstar’s report said.
It also found that only two of the 18 funds that have closed ever breached €100m in assets, and then only for a brief period.
That’s quite an alarming fact about thematic ETFs and something that investors should consider before they hand over any money.
It may therefore be wise to focus on the thematic ETFs which have survived a long time, namely those in the aforementioned areas of technology, the environment and social responsibility.
Technology mostly relates to robotics and automation ETFs, investing in companies developing and using products and services that could one day change the world.
Environmental ETFs relate mostly to those with a water focus, designed to gain from shortages in fresh drinking water exacerbated by climate change and a booming global population.
How sustainable is the investment theme?
Many hot themes turn out to be short-lived fads. Make sure you don’t get caught up in the hype and put money into a thematic ETF which is tracking something that quickly loses popularity.
TECH IS THE MOST POPULAR
According to Morningstar, technology ETFs have by far the most money poured into them by investors, totalling €5.25bn last year. The next highest category, environmental ones, by comparison have €1.27bn.
Investor demand for technology companies in the last decade has seen the sector’s weighting double in the MSCI World Index, the most commonly used benchmark for funds that invest in companies around the world. By comparison, the amount of energy companies in the index has halved.
It’s the returns that lure people in. The popular L&G ROBO Global Robotics and Automation ETF (ROBO) for example returned 40.6% in 2016 and 33.3% in 2017. But it fell 16.6% in 2018, reflecting the volatility often seen in nascent industries with investors who continually demand increasing growth.
Aside from purely looking at returns, a key selling point of thematic ETFs is the diversification benefits they can add to a portfolio.
LOOK UNDER THE BONNET
Once you get past the story of the ETF, always look under the bonnet and consider what it actually invests in.
Matt Brennan, AJ Bell’s head of passive portfolios, says it’s important when investing in areas like technology to pick ETFs that consider all the different companies that will benefit from a particular technology, not just the ones developing it.
TWO EXAMPLES OF THEMATIC ETFS
Here are two ETFs which have recorded strong returns, have a longer track record than the majority and also have a decent amount of investors’ money already in them.
iShares Global Clean Energy UCITS ETF (INRG)
Tracking the 30 largest and most liquid listed companies globally that are involved in clean energy related businesses, year-to-date this ETF has returned 38.4%, although this is behind the 42.8% returned from its benchmark (S&P Global Clean Energy TR USD).
Its performance is also strong over three years (10.6% annualised) and five years (7.2% annualised).
While it does have a total expense ratio of 0.65%, which is on the expensive side for ETFs, it has been going longer than most thematic products having been launched in 2007. It also has a reassuring $270m in assets.
Lyxor World Water UCITS ETF (WATL)
Reflecting the 20 largest companies in the world which operate in the field of water utilities, infrastructure and treatment, this ETF has returned 24.2% so far this year, close to the 24.9% return from its benchmark.
Its annualised three-year return is something of a concern at 6.9%, well below the benchmark’s figure of 12%, but over five years this figure improves to 13.3% annualised.
It has €618.8m in assets and 0.6% annual charges.