Playing a theme

Exchange traded funds (ETFs) have been a game changer for investors – the ease of access to a fund that tracked an index has meant, for as little as the minimum investment on an exchange, investors are exposed to a diverse range of equities.

At its most basic level, the ETF market offers products that track indices like the ASX 300, NASDAQ or S&P 500, as well as diversified multi-asset funds that mix equities and bonds – giving the holder a diversified portfolio within a single product.

That broad focus has meant investors missed out on gains from specific themes; this is where thematic ETFs can play an impactful role in customising portfolios to gain exposure to future themes and megatrends.

Instead of focusing on broad market indices or sectors, thematic ETFs are designed around potential structural shifts the market is expected to react to, taking the game to another level by investing in trends like gaming or cloud computing, climate change, robotics and healthcare.

This type of exposure fills the void between investing in a broad-based fund and investing in stocks directly, meaning investors still reduce the risk of playing the stockmarket directly.

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Over the six months to 30 April, 2021, funds under management in thematic ETFs grew 70% to $4.3 billion.

Over the year to 30 April, 2021, according to FE Analytics, the best-performing thematic ETFs were ETF Securities (ETFS) Battery Tech and Lithium (93.48%), ETFS FANG+ (61.46%), BetaShares Asia Technology Tigers (60.85%), VanEck Australian Banks (60.73%), and BetaShares Global Agriculture Companies (53.76%).

Kanish Chugh, head of distribution at ETFS, said the advantage of thematic ETFs is that it gives exposure to the underlying megatrends.

“You can get those exposures in part by investing in the S&P 500 or the NASDAQ, but you’re investing in the broad index and not getting the actual true exposure,” Chugh said.

“When I’m looking at the overlap of some of the thematic ETFs that we have with some of the broad indices – it’s quite small.

“People that want to get those exposures – now they’ve got the tools to do them.”

Alex Vynokur, BetaShares chief executive, said thematic ETFs offered the benefits of diversified exposure to a particular theme.

“Thematic ETFs are less diversified, unlike whole market ETFs, but the flip side is that it provides a more targeted exposure,” Vynokur said. “It’s a good way for investors to obtain exposure to a theme or sector – traditionally, the way investors used to get these sort of exposures was by trying to pick individual stocks.”

As to what classified as a ‘thematic’, Arian Neiron, VanEck chief executive and managing director – Asia Pacific, defined it as a persistent, structural growth trend that they foresaw over a 10 to 20-year time horizon.

“First thing we do to define it as a thematic is whether we believe it is a structural growth trend,” Neiron said.

“We spend years on this, it’s not something that we go ‘oh, that’s kind of cool, it’s happening in the US’ so it can’t be something that’s in vogue.

“We’re not going to launch an ETF that we think is in vogue or may catch the Reddit or social media momentum.”

Chugh agreed and said the approach to product design meant investors would be putting their money in a fund with longevity.

“When we’re looking to launch an ETF it needs to be long-term, it can’t be a short-term view, so as we build our range we’re going to be looking at long-term structural trends,” Chugh said.

Vynokur said BetaShares had particularly found success with its global cybersecurity, agriculture, and cloud computing ETFs.

“Cybersecurity is a very important theme – fighting cybercrime on one hand is a need for Governments, individuals and companies, but at the same time it’s a tremendous long-term investment opportunity for investors,” Vynokur said.

“One ETF on a lot of people’s minds as there are a lot of concerns over inflation is the global agriculture ETF; a significant portion of investors are expecting some of the largest agricultural companies in the world to continue to benefit as inflation rears its head.

“COVID-19 has accelerated a lot of the trends that we have seen before which is a lot of our business interactions, our entertainment, and transactions are now in the cloud.”

Neiron said he had a personal bias on which thematic fund he thought was most exciting, as his mother was the chief executive of a computer leasing company when he grew up.

“I was fortunate enough to have an Atari 2600… so I do like our video gaming and esports fund,” Neiron said.

“You have three billion gamers and growing, everyone’s got a mobile phone, most people have tablets… and these companies exhibit high earnings profiles.”

IMPACT FUNDS

While funds focused on environmental, social and governance (ESG) had started out as a thematic investment, Christian Obrist, head of iShares - Australasia, said it had now “graduated from being a thematic to becoming more mainstream”.  

Reflecting this, the BetaShares Global Sustainability Leaders fund now had over $1.3 billion in assets under management, far larger than smaller thematic options which could be less than $100 million.

These types of ESG funds tended to negatively exclude companies such as those which had an impact on greenhouse gases. 

Although the US and UK had developed impact investing ETFs, a type of ESG ETF that allowed investors to invest directly in companies that had a positive impact, there were fewer options available in Australia.

BetaShares and VanEck both launched climate change focused ETFs this year and Neiron said there was a transformation in how energy would be produced going forward.

“[We are] moving away from fossil fuels into renewables like hydro, geothermal, biomass, solar and the technologies are becoming cheaper and more feasible,” Neiron said.
Chugh said ETFS had seen a lot of investors come on board its Battery and Lithium Tech ETF recently, which also aided technology being produced for the Green Revolution. 

“We’ve had a lot more flows since October last year through the US election,” Chugh said. “There was this heightened media attention on [US] Government policy around battery technology, carbon emission and electric vehicles.”

The transition in the profile of ESG funds was an indication that areas currently seen as ‘thematics’ now could possibly become much larger areas in the future. 

PORTFOLIO FIT

Having an abundance of alternative options could be overwhelming for advisers however when it came to constructing client portfolios, so thematic products were best used as a smaller segment of an overall portfolio.

Vynokur said the best way to implement thematic ETFs into a portfolio was by using the core/satellite approach.

“[That] approach has been very popular with institutional investors over many decades and now has become very popular in Australia with financial advisers,” Vynokur said.

“It’s a very effective way of ensuring the core portfolio can be built from diversified, low cost, broad-market index exposures and then as satellites investors are able to implement a variety of thematic ETFs.

“We see a lot of advisers go down that path were 80% of the assets will be allocated towards core, low cost, long-term strategies, and then have a 20% towards satellite exposures.”

However, that concept could become complicated depending on the fund and there was flexibility to how that might be approached. 

Big technology stocks were an example, as Chugh said, that could often end up making up the core investment if the core of a portfolio was based around the NASDAQ or S&P 500.

“Say the FAANG [Facebook, Amazon, Apple, Netflix and Google] ETF – that’s multi-thematic, that’s not focused on one theme – it is focused on e-commerce, e-entertainment, autonomous vehicles and even cloud computing,” Chugh said.

“That could be given as a core in a portfolio – a lot of people might say they don’t mind having Facebook, Apple, Google, Netflix, etc., as the core of a portfolio.

“If you’ve got a NASDAQ 100 or S&P 500 [fund] it’s part of your core allocation anyway.”

LIQUIDITY

As thematic ETFs had a narrower scope, there was the perception they could be less liquid than traditional ETFs which was a concern of advisers.

Minh Tieu, Vanguard head of ETF capital markets Asia Pacific, said, as a general rule, they did not have thematic ETFs for this reason.

“It’s definitely something investors should consider, the liquidity,” Tieu said.

“The focus of the ETF is going to be narrower so the universe so the universe of securities it can invest in are narrower.

“Having a broadly diversified index to track allows you to have some of the winners and some of the losers during market volatility and inevitably when markets go up and down, and face some sort of turmoil, you’ll have some winners and losers, but they’ll offset each other.”

However, Chugh said the size of the ETF was somewhat irrelevant because the liquidity of an ETF was based on what it was trying to invest in.

“If you’re trying to invest in micro-cap emerging markets stocks, then yes, you’re going to have liquidity concerns,” Chugh said. “If you’re investing in the big FAANG names, you’re not going to have an issue.

“As a provider, we have to do due diligence when we create a product to ensure the index that we’re going to be tracking and the stocks that are going to be included are liquid enough for investor to buy or sell out of.”

“How much funds under management a fund has is redundant. Why? It’s only as liquid as the underlying [stocks],” added Neiron.

Vynokur said it was important for investors to do their homework and understand the methodology of a particular index they were looking to allocate to.

“Every ETF in that thematic category applies a liquidity screen to ensure the companies that end up being constituents pass stringent liquidity criteria,” Vynokur said.

“That is done to ensure investors are able to buy or sell their investment at a competitive unit sort of with plentiful liquidity.”