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What is a thematic ETF?

April 25, 2021

5 minutes of reading

Comments expressed by Businessmen the contributors are their own.

There’s no need to remind our readers of the massive growth in recent years ETFs (Exchange Traded ), managed and traded passively on one . By 2020, the asset flow of ETFs will for the first time exceed $ 7,000 billion and account for a third of the total assets managed by the fund. According to Moody’s, ETFs may soon exceed the aggregate size of traditional mutual funds. Initially, ETFs copied well-known national or regional equity indices such as the S&P 500, such as the famous SPDR or QQQ that copied the Nasdaq 100. A few years ago, trackers on specific areas that are trending.

A “ Clean Technology ” ETF can invest in the entire value chain.

More recently, Thematic ETF has started to become popular. They allow investors to invest through a single instrument into a basket of stocks related to a particular topic, such as electric cars, cannabis, cybersecurity, clean energy or products. vegan products. While the composition of domain ETFs primarily follows the classification and hierarchy determined by an existing index, thematic ETFs are related to a number of different disciplines.

For example, Global X Robotics & Artificial Intelligence ETF invests in semiconductors, industrial stocks, software, and medical equipment. A Clean Tech ETF can invest in the entire value chain, from engineering to marketing to the end buyers. Various companies such as Marvell, Plug Power or First Solar can be found. What do they have in common? Their exposure to the same subject.

Related: Why should new investors start with some allocation to ETFs as they build their portfolios

Increasingly successful

Currently, the thematic ETF represents no less than 800 instruments with more than $ 180 billion in assets under management. Their leader is Ark Invest, founded by Catherine Wood, the new “star” of Wall Street. In just a few years, the New York-based company became the 7th largest asset manager with over $ 300 billion in assets under management. Their “secret sauce”: topics that speak to investors (innovation, genes, robots, fintech, etc.) but also have exceptional performance (105% average in 2020). Ark Invest’s success is such that it is inspiring a new investment strategy on Wall Street: copying or even predicting investment decisions made by Catherine Wood.

But be careful! Ark Invest’s exceptional success has also been overshadowed by failures. More than half of the thematic ETFs launched in the past ten years have disappeared. Indeed, these trackers are often launched based on pure commercial logic, that is, to acquire the asset as quickly as possible in order to maximize management fees. Usually, the problem is not to choose stocks on a proven index or on certain fundamentals, but to “craft” a story that will appeal to retail investors. However, when performance is not achieved, the ETF’s assets drop to levels that are not sufficient to cover operating costs, forcing asset managers to close the ETF in question. Among the thematic ETFs that closed in 2020 are SLIM and DIET (nutrition).

Related: Exchange-Trading Funds vs. Index Funds

Topic ETF’s: pros and cons

For many investors, building a portfolio is not always easy. As the market rallies, fears of an impending correction dampen the enthusiasm of newbies. On the other hand, market downturns are often accompanied by bad news on the macroeconomic level – which is not conducive to a “jump” into the financial markets. First-time investors will get involved more easily by identifying topics on which they have personal beliefs. For example, many of us believe that innovation companies have great potential. Hence, an ETF labeled “Innovation” is more likely to “pull money out of your pocket” than a “Balanced Risk Profile” type fund.

At the end of the day, thematic ETFs offer little diversification for investors.

Thematic ETFs allow investors to invest in a variety of funds, with low initial investment and low management costs (even though they are still higher than “classic” ETFs). In terms of topic visibility, managers use sophisticated dosing tools, sometimes based on artificial intelligence.

However, there are pitfalls to avoid. For example, thematic ETFs offer little diversification for investors. The topic of cannabis, for example, has had its ups and downs. Since stocks are highly correlated with each other, the volatility of cannabis ETFs is not too far from the volatility of the underlying assets.

Another downside – and one important one – is performance. A recent study performed at Fisher University in Ohio found that thematic ETFs have recorded below-average risk-adjusted performance. This performance is also correlated with cash flow. Themed ETFs are often marketed when the subject has performed well. But when the trend turns, investors decide to sell their ETFs, creating a vicious cycle of negative outflow and underperformance. The same study also found that the underlying assets were overvalued when the ETF was created. On average, thematic ETFs generate a negative alpha of -4% per year and therefore do not create any additional value for investors.

Related: 3 ETF fields to buy now


We Thematic ETF should be avoided? Unnecessary. As with any investment, it is important to carefully analyze the fundamentals of the underlying instruments (pricing, growth prospects, etc.), the basket’s diversification character, as well. such as technical aspects such as prospectus or issuer’s solidity. In general, this type of instrument can be useful on the periphery of a diversified portfolio across major asset classes.



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