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.

Tech roars back as investors Martingale on Tesla, ITV shares down (after Morgan departure?)

Morning Note

Tech roars back: As I said last Friday, this is the kind of market that will trap bulls and bears alike. So yesterday was the classic Turnaround Tuesday as tech came roaring back following Monday’s sell-off. The Nasdaq 100 raced 4% higher and the Composite index rose 3.7%. We can put some of this down to short covering, but equally it seems the market cannot make up its mind in terms of rotation and bond yields. Today’s 10-year auction will be key – a sale of 3-year paper yesterday went off rather well and helped eased yield concerns, with the 10-year dropping 5 basis points to 1.54%. Asian shares failed to pick up the baton and European shares were mixed in early trade on Wednesday after eking our small gains on Tuesday, which followed Monday’s solid rally. The DAX trades near its record high, whilst the FTSE was down 0.5% in early trade under 6,700.

 

The risers among the tech space were among the big momentum stocks of last year: Tesla rose 20%, Peloton +14%, Baidu +14, DocuSign and Zoom both +10%. Beware these markets – they will take out both shorts and longs. Whilst the rally in tech lifted all boats, the Dow Jones only managed to rise 0.1%, slipping sharply in the last hour of trade after hitting another intra-day high at the top of the session. The S&P 500 advanced 1.4% to 3,875. This huge volatility in such a large stock as Tesla is going to be important. The sheer number of ETFs with exposure to Tesla and – by extension Bitcoin – is vast.

 

Martingale: a gambling system of continually doubling the stakes in the hope of an eventual win that must yield a net profit. Now yesterday we talked about Cathie Wood of ARK, who said she’s used the market pullback in tech stocks to dump some more liquid stocks, which also happen to make money, like Apple, in favour of her ‘highest conviction’ bets, which promise to do so some time in the future. Now this strategy of doubling down paid off handsomely yesterday as Tesla – the Innovation fund’s biggest holding – rebounded 20% and the ARKK Innovation ETF rose 10%. Timing matters a lot in investing, and I would argue that Cathie got a bit lucky with the bounce back being so strong, particularly as we are yet to see the impact of today’s 10-year bond auction across the pond, which could have serious reverberations around global markets if it goes off like the last 7-year sale. Moreover, I think yields will rise further – historically they are way below where they should be on an expected growth basis. This was one day, and momentum continues to trail value, and ARKK is still down over 20% from the peak set earlier this year. Continually Martingaling like this is surely not an advisable investment strategy, no matter how successful you have been before: past performance and all that…  

 

Anyway, tech soared yesterday, and volatility was crushed. The market wants to go up even as higher bond yields make people worry about tech valuations. Despite this, short positions on Tesla are estimated to have delivered $4.2bn in profit so far in 2021, according to estimates from Ortex. On the other hand, losses on GameStop short positions are estimated to have lost traders a total of $11bn YTD. Those losses rose again on Tuesday as GME surged another 27%. The put-call open interest ratio stands at a sturdy 3.37, with short interest at 23.6% still, according to Refinitiv data. GME was up another 5% in after-hours markets – at what time does the Street start to weigh in properly on the business’s fundamental case. I can see someone looking to grab a headline by supporting the fundamental case. Current consensus rating is at $16.80, implying a roughly 93% downside. YTD it’s up 1,200%.

 

Biden’s recovery plan will boost the global economy, according to the OECD. When you dump 10% of GDP on the world’s economy in stimulus, I’d be mighty surprised if that were not true. What’s more of an issue is just how much money is being printed vs the benefit to the economy. It’s not going to be a terribly efficient use of cash. No one is that bothered about this now – but it could become a problem once the economy is back to normal. Morgan Stanley raised its 2021 US GDP forecast by .5pp to 8.1% Q4 noting that reopening is progressing, vaccinations are ramping up and the labour market is gaining momentum. 

 

Amid and because are very different things. You can say shares are down ‘amid’ a regulatory investigation, or you can say shares are down ‘because of’ an investigation. The latter is more forceful, the former safer for writers and commentators if they are unsure why shares are doing what they are doing – sometimes shares go up or down for no reason at all. ITV shares are down over 4% this morning after the departure of Piers Morgan. Are they down because of this event or just amid his departure? Investors may be a little worried about the loss of ratings for GMB – it wasn’t exactly doing that well before he joined and its primetime slot will have repercussions for ads. Love or loathe, Morgan boosted ratings. It could also be that investors are worried about an investigation over comments made by Morgan on air. Shares were hit yesterday after it revealed the way in which lockdowns have hit ad revenues, but indicated things are picking up and Studios can drive new growth. DB today calls it a buy. You cannot be owning ITV and worry about one host, can you?

 

A clear pandemic winner, JustEat reported revenues rose 54% to €2.4bn, whilst adjusted EBITDA came in ahead of forecast at €256m, driven mainly by growth in Germany, Canada and the Netherlands. It still doesn’t make a profit on an IFRS basis. The company expects continued strong demand through 2021 as the momentum from lockdowns persists beyond the end of restrictions. New customers have been attracted to the platform and even if they don’t order as much, consumers are fairly sticky once they land. The company said it processed 588 million orders in 2020, representing a 42% increase compared with 2019 as it enjoyed three consecutive quarters of order growth acceleration last year. Investors will be pleased to see the improvement in Delivery efficiency as this lower-margin business makes up a much larger part of group earnings – the share of Delivery orders rose to 26% from 18% in 2019. The Brazilian business is picking up momentum but management reiterated that they remain willing to sell the 33% stake in iFood “if appropriate offer is made that reflects the size and superior growth of this asset”. JustEast says it has turned down several bids, the highest of which amounted to €2.3 billion. Shares advanced 0.7% in early trade.

 

Gold has recovered on the multi-year trend and multi-Fib support around the $1,695 (61.8% of last year’s rally corresponding with the 38.2% retracement of the 2016-2020 rally – see chart below) area to reclaim the $1,714. Level. Next stop for bulls will be $1,724 but yields are key. A breakdown around $1,690 calls for a retest of $1,585 area.

Gold has recovered on the multi-year trend and multi-Fib support around the $1,695.

Gold has recovered on the multi-year trend and multi-Fib support around the $1,695

Copper prices are in consolidation following a 10-year peak that was driven by a speculative pile-on (supercycle bets) and as rising Chinese stocks are starting to reduce the backwardation in the futures curve. Rising yields and a stronger dollar are also a factor. I would see this more as consolidation that a reversal.

Copper prices are in consolidation

Stick or twist? Markets pin hopes on Fed chair Powell

Morning Note

Jay Powell, chairman of the Federal Reserve, speaks today at the WSJ’s Jobs Summit. We know the Fed’s policy on jobs already; what the market cares about is the central bank’s response to volatility in the bond market. This will be the last time we hear from Powell before the blackout period for Fed speakers ahead of the March 16-17th meeting.  

 

One option is for the Fed to embark on a third edition of Operation Twist, a policy that was last attempted in the wake of the last crisis. Twist simply refers to selling shorter dated government debt whilst simultaneously buying the same amount of longer-dated maturities. It attempts to control the yield curve by flattening it out – or ‘twisting’ it. It has the advantage of allowing the Fed to get a grip on both ends of the curve whilst not expanding its balance sheet. With the Fed committing to keeping short-term rates at zero for at least another couple of years, the effect on short-term rates should be small. Yesterday Philadelphia Federal Reserve president Patrick Harker stressed that rates won’t be rising in 2022, and that yield curve control is a tool in the Fed’s armoury. Lael Brainard hinted two days ago that the Fed is starting to pay attention to bond market volatility.

 

For the Fed it’s time to stick or twist. We know the RBA has started to blink, and ECB policymakers have been talking up how they won’t tolerate higher yields, albeit the messages have been a little mixed of late. The Fed has carried out Twist twice before – once in 1961 to strengthen the dollar, and again in 2011 during the sovereign debt crisis in Europe when rates were already at zero. The question is whether the Fed worries about the market stresses we are seeing, or whether it thinks the rise in yields is more about good economic news. The problem it has and has had for many years is that we are in world hooked on ultra-low rates so any move up reveals skeletons. 

 

Tech stocks are leading broader markets lower as a sell-off in government bonds picked up again. The yield on the 10-year US Treasury note rose to nearly 1.5% again and seems destined to nudge its way higher. US 5-year break even inflation expectations have risen to 250 bps, the highest since mid-2008. Yesterday the Nasdaq 100 cracked its 50-day moving average to close at 12,683, its weakest since the start of January. It’s now down for 2021 and is about 10% off its recent all-time high. The S&P 500 closed on a key trendline support at its 50-day SMA. It looks like it could be the moment for a crack – Powell could be make or break today. Tesla shares are down over 25% from their peaks. Cathie Wood’s main fund, the ARKK ETF, has shed 20% from its February high as the likes of Square, Zillow and Pinterest all tumbled in the region of 8%. Rocket Companies, which had become the next meme stock darling, fell out of orbit and crashed over 32% to $28.

 

After a decent day on Wednesday, European bourses took the cue from the decline on Wall Street that preceded a soft session in Asia as shares in Tokyo and Hong Kong both fell over 2%.  The FTSE 100 declined around three-quarters of a percent in the first hour of trade

 

Deliveroo has confirmed it will list in London and retain a dual class share structure. The timing is noteworthy since it comes a day after the Hill review. Deliveroo won’t be eligible for a premium listing – and the inclusion on FTSE indices that goes with it – but it soon will be.  

 

The review, which the chancellor endorsed in the Budget, calls for companies with dual class share structures to be able list in the premium listing segment, with some caveats to help protect investors, e.g. the dual class structure would be permitted for a maximum of 5 years and voting rights would be capped at a ratio of 20:1. It will also see the free float requirement lowered to 15% of available shares from the current 25%, and it will create a much easier regime for SPACs – blank cheque companies that are created with the aim of acquiring another business. Now the SPAC craze in the US may not be something we really want to emulate.  As Hill states, “listing on the premium listing segment of the FCA’s Official List has historically been globally recognised as a mark of quality for companies”, which begs the question of the merits of ‘watering down’ ‘the rules.

 

But the principle of evolving the listings rules for today’s markets, today’s technology, today’s investors, and the reality of Brexit, do make sense. For example, Hill notes that “it would be helpful if the FCA was also charged with the duty of taking expressly into account the UK’s overall attractiveness as a place to do business”, as happens in other countries. It also makes recommendations to consider how technology can be used to improve retail investor involvement in corporate actions. These would clearly be positives.

 

Tech firms may be attracted to London as a result of the changes. Between 2015 and 2020, London accounted for only 5% of IPOs globally, in large down to the appeal of Asia and New York for tech firms. But equally it’s about the depth of the market and multiples – are we really able to raise the kind of investment into tech start-ups from London that US bankers can achieve for Silicon Valley?  

 

Elsewhere, OPEC failed to reach agreement yesterday and reconvene today. Chatter of OPEC and allies rolling over cuts has helped support prices after touching the weakest since mid Feb. Crude oil inventories rose by over 21m barrels, the most in nearly 40 years as the weather in southern US has shut in refineries. The build came amid a 13.6m draw in gasoline stocks, which was the largest since 1990. and a 9.7m draw in distillate stocks. 

 

Finally, some good news: JD Wetherspoon will open 394 pubs on April 12th for outside service in gardens and terraces. Opening hours are 9am-9pm. I expect demand will be high. Shares nudged higher after a solid gain following yesterday’s Budget announcement, which provided more business relief and support for hospitality.

 

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