Themes for investor dreams

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This article was published 03/02/2024 (952 days ago), so information in it may no longer be current.

If you want to get a piece of the action of companies involved in artificial intelligence, robotics or even space travel, there’s likely an investment fund to match your speculative hunch.

Called ‘thematic ETFs’ these investments put a different spin on traditional exchange-traded funds.

Exchange-traded funds — ETFs for short — have been marching toward investment industry dominance for more than two decades, made popular by offering low-fee, highly liquid (easily tradeable) portfolios that are broadly diversified.

The world’s largest is the SPDR S&P 500 ETF Trust, managing nearly a trillion dollars, providing direct exposure to the world’s largest stock market index, the S&P 500, for a management fee of 0.09 per cent annually.

Yet the ETF universe is continually expanding. And much of that expansion comes from thematic ETFs, which focus on specific market trends and investment ideas.

Simply, if investors can dream it, the investment industry will theme it as an ETF.

Hundreds of thematics are now listed on Canadian, U.S. and stock markets. And new entrants are popping up constantly, including 11 recent offerings from a U.S.-based provider called Themes ETF.

Launched in December, the Washington, D.C. area fund company’s lineup includes its Themes Generative AI ETF (WISE), which includes big tech companies like Microsoft, NVIDIA and e-commerce giant Amazon.

But WISE also holds less popular AI players like microchip maker Advanced Micro Devices Inc.

Another Themes offering is the European Luxury ETF (FINE) with exposure to companies like LVMH Moet Hennessy (owner of Louis Vuitton) and high-end fashion giant Burberry Group.

“We think thematics today represent an incredible opportunity,” Taylor Krystkowiak, vice-president and investment strategist at Themes ETFs.

The reason being is the higher interest rate environment. Unlike the last decade of ultra-low rates that boosted the values of all stocks, more targeted approaches focused on certain trends could excel in today’s higher rate environment, he adds.

AI is a good example. Much of the growth in the U.S. stock market last and this year has been driven by companies involved in AI, and it’s likely a trend that will continue for the many years.

Thematic ETFs are not for everyone, says Linda Ma, vice-president of ETFs and financial products research at National Bank of Canada Financial Markets.

“In general, thematic investors must … have a high risk tolerance.”

She further notes that these funds, being more targeted to certain parts of the stock market, are typically very volatile, prone to large price swings.

Still, thematics do actually offer a less risky way to invest in specific market trends.

Ma points to funds like Horizons Robotics & AI Index ETF (RBOT), listed in Canada. It provides exposure to companies like Intuitive Surgical Inc. and Japanese industrial robot maker Yaskawa Electric Corporation among its 46 holdings, and it is likely less risky strategy than picking one or two companies you think will be the eventual top performers long-term in this emerging industry.

Not all thematics are focused on technology themes. They may also cater to environmental, religious and political interests, including the Freedom 100 Emerging Markets ETF (FRDM), Ma says. FRDM holds the top emerging market companies in nations that score highest on personal and economic freedoms.

If you’re wondering just what those ‘freedoms’ might be, you’re not wrong to ask.

Indeed, investors need to carefully look under the hood of thematic ETFs to understand how they select their underlying investments. Most of the time, investment selection is based on an index. The Freedom fund, for example, uses the Life + Liberty Freedom 100 Emerging Markets Index, scoring emerging market nations on 83 quantitative variables.

Yet not all thematics track indices. Some involve active management, most notably those from Ark Invest.

“Ark took the industry by storm when in 2020 their funds were among the top-performing of all funds,” says Danielle Neziol, vice-president of ETF online distribution at BMO ETFs.

The U.S. ETF provider is led by all-star, U.S. money manager Cathie Wood, and BMO recently partnered with Ark to offer Canadians Toronto-listed versions of Ark funds.

That includes its most popular, the Ark Innovation ETF (ARKK), which had a 152 per cent return in 2020.

Yet ARKK typifies how thematics can be a wild ride for investors. The ETF decreased about 23 per cent in 2021 and then plunged 67 per cent in 2022. But last year, it grew 68 per cent.

Because Ark ETFs are actively managed, they also come with higher management fees—though at 0.85 per cent, the annual cost is less than half of the fee for a typical equity mutual fund.

Ark’s additional cost, however, have been worth it given the “level of research and nimbleness from Ark’s active management team, allowing it to buy and sell stocks without being constrained” by an inflexible index, Neziol says.

Indeed, an active approach can align well with rapidly changing trends, like AI.

“Ultimately, thematic ETFs like Ark’s can be good satellite positions in a well-diversified portfolio to tilt it toward faster growing, though riskier, parts of the market,” she adds.

Young investors could even consider thematic ETFs as core holdings if they have time horizons to invest in themes with very strong, albeit volatile, growth trajectories that could last two decades or more, Krystkowiak says.

“You can also use thematics tactically — like if you believe the airline industry will see a boost in business in the next six months,” he adds.

Unsurprisingly, Themes has an ETF for that too — its Airlines ETF (AIRL) that holds the world’s 30 largest airliners.

Whatever the use case, thematic ETFs require more homework than broad-based ETFs tracking a big market index, Krystkowiak cautions.

Yet thematics do arguably offer the least risky and easiest means to invest in market trends, he adds.

“It’s obviously a lot easier than trying to buy, hold and rebalance AI 40 stocks on your own.”