If you can dream it, they can theme it

Hey there, time traveller!
This article was published 08/05/2021 (1960 days ago), so information in it may no longer be current.

Choose almost any investment idea and there’s an ETF for that.

Hold on.

What’s an ETF, you might ask?

Well, it’s an exchange-traded fund, and it’s largely displaced mutual funds as a way for investors to purchase baskets of stocks for a small fee.

Often the fee is a 10th of mutual fund fee. As well, ETFs trade like stocks on exchanges.

Typically, they involve passive management. That means, generally, there is no investment manager picking stocks. Rather, ETF stock selection is often based on reflecting the index. For example, the world’s largest ETF is State Street’s SPDR S&P 500 ETF with about US$400 billion in assets under management, and it follows the performance of the S&P 500, for a management expense ratio (MER) of 0.09 per cent.

Since ETFs started around the 1990s, their attraction has always been low-fee, broad-based diversification. The premise being: paying higher fees for expert management in mutual funds rarely outperforms the benchmark index — like the S&P500 — over long periods; so why pay for more when you can buy the index via an ETF for much less cost?

The notion has been increasingly popular over the last 20 years, with about $200 billion invested in ETFs in the early 2000s to nearly $8 trillion today.

It’s a booming industry, and that of course, begets more innovative product.

Enter thematic ETFs. Rather, than mirroring a broad stock index, these products still reflect the performance of an index, but generally the index is focused on a narrow market segment — like space, gold miners, wind energy or cannabis.

“Thematic ETFs have grown exponentially over the past five to 10 years, but even more so in the last 12 months,” say Lara Crigger, managing editor at ETF Trends in the U.S.

Their popularity can be attributed to a few things, she adds.

“They’re probably the easiest investment vehicle in the entire industry for investors to understand,” she explains.

“They have a clear and obvious story, and it’s often one that excites.”

As well, during the pandemic, thematic ETFs have caught the fancy of legions of locked-downers with stimulus money to burn.

But there is also good reason to invest in thematic ETFs because they offer diversified exposure to fast-growing parts of the market. (Do keep in mind thematic MERs are a typically more costly than broad-based ETFs, often 0.4 per cent and higher.)

“In a lot of cases, these are emerging industries that are going to go to the moon, so to speak,” Crigger says with laugh, referring to the popular credo of the Reddit investors who follow the speculative sub-feed wallstreetbets behind stonk investing (i.e. GameStop).

In fact, there’s an ETF for even that style of investing: VanEck Vectors Social Sentiment ETF (ticker: BUZZ).

One of the more popular brands is ARK, which runs counter to traditional ETFs. Its funds are actively managed, led by Cathie Wood. Among its ETFs is the ARK Innovation ETF, which has led all thematic ETFs with asset growth over the last year, attracting almost $16 billion. More recently, the firm rolled out its ARK Space Exploration & Innovation ETF, which garnered more than US$600 million since inception at the end of March.

Another popular theme among ETFs — one that’s less speculative — is ESG (environmental, social and governance).

“We’ve seen a really big trend of growth take place in the last two years in ESG ETFs,” says Rene Reyna, head of thematic and specialty product strategy at Invesco — one of the world’s largest ETF firms.

“To put it in perspective, we saw about 97 per cent year over year growth rates in 2020 versus 2019.”

Invesco — for that matter — just launched its Invesco MSCI Green Building ETF.

“You really can’t have a conversation about decarbonizing without including buildings,” he says, noting they account for about 39 per cent of global greenhouse gas emissions.

As such, the fund invests in real estate, builders and other entities involved in constructing net zero buildings or retrofitting old ones.

For the green-minded investor, seeking real estate exposure, it’s an attractive idea.

Yet that’s also of the challenge with thematic ETF, says ETF expert Daniel Straus — director of ETF research at National Bank of Canada Financial Markets. There are so many good ideas to invest it, you can get carried away.

“If space seems like a high-growth area, then what about blockchain, robotics and automation, cloud computing, and lithium batteries?”

He further notes thematic ETFs should not take up more than 30 per cent of your portfolio — and even that’s a little too high. Certainly, you wouldn’t want more than 5 per cent of your portfolio allocated to any one thematic ETF, Straus adds.

“There are so many themes… that if you allocated that much to even a few, it’d make up most of your portfolio pretty quickly.”

Crigger agrees investors need to be mindful of picking too many themes.

“It is so easy to get swept up in good story… but too much of your portfolio in thematics is a recipe for pain.”