Thematic ETFs fell down to earth — is it time to look again?

Having enjoyed strong returns and inflows earlier in the pandemic, thematic ETFs have come down to earth with force. Demand for such products has wilted, with flows into thematic ETFs across Europe amounting to €0.6bn (£0.5bn) in the first quarter of 2022, the first quarter since 2019 where they attracted less than €1bn.

That reflects some dire performance: to cite some of the hardest hit, the VanEck Crypto and Blockchain Innovators Ucits ETF notched up a brutal paper loss of 74 per cent in the first half of 2022, while the ETC Group Digital Assets and Blockchain Equity UCITS ETF was down 67.7 per cent over the same period. As our chart below shows, a good number of other funds have nursed losses of at least 30 per cent over that time — from a sample of about 50 thematic ETFs, just five have ended this six-month period in the black.

These extreme examples lay bare some of the key risks of thematic ETFs. They can have a notable exposure to growth stocks, tech and the US market more broadly, and also tend to focus on overly hyped-up areas. That leads to the following concerns: that they expose investors to a trend or sector just as demand and valuations peak, that portfolio construction techniques can leave them either overly concentrated or only tangentially focused on a set theme, and that they require a high level of due diligence. This is why thematics have once again had a limited showing in the latest Investors’ Chronicle Top 50 ETFs list.

But if research has pointed to their failings, we do appreciate that such products can fill gaps in portfolios and are increasingly important to certain investors. We also note that some themes may have the longevity to reward investors in the longer term, even if the ups and downs can be severe. So while not many thematics have made our latest list, we have followed the convention by outlining the options currently exciting our expert panel.

This article was previously published by Investors Chronicle, a title owned by the FT Group.

The iShares Automation & Robotics ETF (RBTX) is down by nearly 30 per cent over a six-month period and is a good example of the sell-off tearing through the thematics space. But while it is unsurprisingly exposed to the problems being suffered by growth investors and US tech, the fund continues to target a noteworthy theme. It’s reasonably priced for a thematic product at 0.4 per cent, has billions in assets and is diversified across around 160 holdings, none of which made up more than 1.3 per cent of assets in late June. About half the portfolio was in US shares, with a 15 per cent allocation to Japan.

As with other sectors, funds like these can have overlap with more mainstream global and US funds, as well as technology funds. It’s also worth conducting substantial due diligence, keeping an eye out for any changes to the underlying index methodology, and comparing the fund with its rivals. One of our panellists continues to prefer an L&G rival to this fund, in part because of the regular due diligence the provider itself carries out on the holdings in its thematic ETFs.

The iShares Ageing Population Ucits ETF (AGES), while sitting on some considerable losses, has been much less badly hit than those thematics with more of a tech focus. Importantly, it focuses on a trend that should significantly affect companies over time, and drive returns for those invested in the right areas.

Investment themes like these can be open to interpretation, meaning funds may differ from a buyer’s expectations in terms of what they hold. This might be a case in point: the fund, which recently had nearly 400 holdings, did have a substantial healthcare allocation as some might expect, accounting for about half of its assets. But other sector allocations might surprise, particularly the fund’s 36.4 per cent weighting to financials. In terms of geography it’s fairly heavily weighted to the US, which made up 52.3 per cent of assets.

To turn to the fund’s remit, it looks to hold companies that “specifically provide products or services to the world’s ageing population”, and this ranges from pharmaceuticals companies to insurers and consumer discretionary businesses. It’s a relatively broad interpretation of the theme, but that does dilute any sector-specific risk. This is another large fund and comes with a 0.4 per cent price tag.

The iShares Global Clean Energy Ucits ETF (INRG) is the poster child of the thematic ETF world. We decided to stick with this fund last year after liquidity issues triggered an overhaul of its underlying index. As we argued, big changes to the fund that included a significant increase in its target number of holdings make it more liquid and diversified. It remains a controversial fund, but a popular one with an appealing long-term theme.

It’s worth noting that the fund operates in a relatively crowded space: a handful of clean energy ETFs exist, as do more targeted plays such as hydrogen economy ETFs. Active options exist too, presenting plenty of choices for investors interested in the theme.

One separate gripe about this fund relates to its price: a 0.65 per cent fee feels pretty steep for such a large ETF, even if it is a specialist product.

Finally, the iShares Digitalisation Ucits ETF (DGIT), with its focus on digitally focused services in developed and emerging markets, still strikes us as a fund with a durable theme. The fund recently had 218 holdings and invests in all manner of companies, from parcel delivery names to cyber security businesses, payment processing giants and most of the Faang stocks. But unsurprisingly it does have a bias to both the tech sector and the US.

We continue to like the theme behind this fund, as well as its size and 0.4 per cent fee. But as with other tech-minded thematics, do consider the risk of doubling up on the same holdings if you also use the likes of global, US or technology funds.

*Investors Chronicle is a 160-year-old publication owned by the Financial Times offering an expert and independent view of the investment market. It provides educational features, investment commentary, actionable tips and personal finance coverage. To find out more, visit investorschronicle.co.uk

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