Thematic Investing with ETFs

Thematic investing and ETFs go hand in hand. Here’s a quick overview of what both entail so you can get started on a theme-led trading or investing strategy.

A look at ETFs and Thematic Investing

What are ETFs?

ETFs are exchange traded funds, a financial product that combines the properties of a funds and equities.

Each exchange traded fund is composed of different assets grouped together. These might be equities, commodities, bonds, or a mixture of all of them. The assets inside an exchange traded fund track the performance of the fund’s underlying market as closely as possible.

An ETF vs an Index fund

There are some similarities between the pair, but ETFs and index funds do hold some key differences. Here’s a very quick outline of what separates the two.

  • ETFs can be bought and sold at any time, whereas index funds are only available at the price set at the end of the trading day.
  • Exchange traded funds generally require lower minimum investment
  • ETFs are typically more tax efficient

For retail investors and traders, an ETF may be the better option, but this of course all depends on individual goals, personal capital expenditure and so on.

Do ETFs pay dividends?

That depends on the type of ETF. An income fund will distribute any interest and dividends back directly to you, as the name suggests.

An accumulation fund, on the other hand, will not pay a dividend. Instead, it will reinvest any accrued gains back into the fund, raising the value of your investment.

Both are valid options, but again it depends on what you are trying to achieve when investing or trading an ETF.

How does thematic investing apply to exchange traded funds?

The beauty of ETFs is that they are perfectly suited to a thematic investing strategy.

By their very nature, they group together specific assets into one product. They offer exposure to trends, industries, technologies and sectors all in one product – ideal for those who do not want to do they analytical legwork associated with other forms of investing and trading.

One thing in common with thematic ETFs is that they tend to be forward-facing. Many of the available funds out there focus on disruptive technologies and trends.

For instance, cryptocurrency and bitcoin is huge business right now, as one of the most popular trends amongst millennial investors. If this piques your interest, you may want to invest in a crypto-themed ETF.

A space travel-focussed ETF will cover numerous assets around space exploration, i.e. companies that offer commercial space flight, rocket engine manufacturers, raw materials suppliers, and so on.

Cathie Woods’ ARK series of technology-driven ETFs are the perfect example of themed funds. Each is split into different niches and ideas based around disruptive technologies:

  • Innovation
  • Fintech innovation
  • Autonomous technologies & robotics
  • Next generation internet
  • Genomic revolution

So, for example, the fintech innovation fund is based on “innovative and disruptive financial technologies.

“Companies represented within ARKF transaction innovations, blockchain, risk transformation, frictionless funding platforms, customer-facing platforms, and new Intermediaries”.

By packaging assets in the fintech space together into a single tradable asset, investors in that ARK ETF would be gaining exposure to multiple assets and mitigate their single stock risk.

How popular are thematic ETFs?

Very. In Europe alone, thematic ETFs attracted a record €9.5bn in new assets across 2020, bringing the total assets under management (AUM) for thematic funds up to €22.7bn – an all-time high.

In the US, thematic ETFs AUM stands at $183 billion, according to Global X’s Q1 2021 thematic investing report. That represents 2% of the US’ total ETF sector, but, crucially, 7% of revenue. That may look small, but growth has been massive.

Global X reports that US thematic exchange traded funds’ assets under management has risen 430% since Q4 2020. The volume of inflows has tripled since 2019. Aggregate AUM reached $133.1bn at the end of Q1, up 28% from the $104.1bn AUM achieved at the end of Q4 and exceeding the broader US ETF industry’s 7% q/q gain.

There are now 163 thematic exchange traded funds listed on US exchanges – an increase of 13 over Q4 2020. None have been closed either.

In terms of returns, we can look at the performance of some European ETFs to see what makes them a popular choice for retail investors. Some of the funds with the highest ROI include:

  • iShares Global Clean Energy ETF (INRG) – 120%
  • WisdomTree Cloud Computing ETF (WCLD) – 92%
  • VanEck Vectors Video Gaming and eSports ETF (ESPO) – 68%

Risks of thematic investing with ETFs

As with any financial product or asset, the value of an ETF can rise or fall. As such, you can lose money, so only invest or trade if you are comfortable with any potential losses.

There are risks around liquidity too. A surge in investor interest in a specific sector may cause a rally in a fund’s underlying index or component assets. If this is the case, investors may start selling their holdings, and trigger a liquidity shortage. The fund would have to be rebalanced accordingly to protect against this.

As ever, due diligence and research are important here. Make sure you do yours before committing any capital.