Thematic ETFs: The Importance of Being “Earnest”

When it comes to thematic ETFs, everything seems to have been said and read - from extreme enthusiasm to extreme scepticism. Since we expect them to generate narrative alpha, the debate can be an emotional topic and is never neutral. However, there has never been such an opaque investment universe as no standards to define it have yet been adopted by the industry.

A fast-growing universe

Despite a lack of consensus on the definition and, consequently, the number of thematic ETFs, this investment universe has found its avid audience as demonstrated by the flows generated so far, regardless of data source. Since 2018, a 3x growth has been estimated across the industry. Trackinsight validates this expansion rate and identifies almost 600 thematic ETFs worldwide, totalling close to USD 300 billion in AuM as at 30 June 2021. In 2021, one-third of ETFs launched is thematic, representing a total flow of more than USD 65 billion.

Emerging themes and trends

The rise of thematic ETFs has been accelerated by the 2020 Lockdown Crisis changing drastically our daily life and references. In terms of inflows and performances, trends such as Disruptive Technology and Digital Infrastructure & Connectivity were the winners of 2020 with more than USD 100 bn of AuM last year. Interestingly, in the first half of 2021, a thematic rotation occurred, favouring more value-driven trends such as Climate Change and Infrastructure respectively carried by the momentum of a Net Zero target and US President Biden’s infrastructure plan. With AuM totalling above USD 50 bn as at end-June 2021, Digital Infrastructure & Connectivity remained a steady bet in 2021. In Q1 2021, Disruptive Technology lost traction in investors’ hearts, before bouncing back over Q2 2021, reaching a total of around USD 65 bn in AuM at the end of the first semester.  (Source: Trackinsight)

Thematic ETFs: The Good, the Bad, and the Ugly

As a very heterogenous universe, in terms of composition and performance, no two thematic ETFs are alike. Most thematic ETFs rely on a quasi-active stock selection process. Indeed, some of them passively replicate an active or smart beta index while others are even purely active.  In terms of portfolio construction, four different approaches are emerging: stock picking based on corporate fundamentals and growth potential; the use of industry experts; the use of AI and Big Data; and combinations of all three. Without favouring any of them, it is important that investors dive deep into the investment process through a thorough due diligence to assess the strategy’s purity and its capacity to capture any long-term trends.

In a nutshell

Given that thematic investment redefines sector, geographical, and style allocations by breaking traditional frontiers, it is crucial for investors to fully know the thematic ETF in which they are investing. Indeed, investors must not be ignorant about the actual investment risk they are taking and should always look beyond the fashionable name of the thematic ETF. For as Oscar Wilde says in the play referred to in our title, “Ignorance is like a delicate exotic fruit; touch it and the bloom is gone.”

Published by RankiaPro Europe in the September 2021 Edition.