St. Patrick’s Day is one of my favorite occasions to throw a party. This past weekend, I hosted a St. Patrick’s themed party at my house, featuring an updated take on a traditional Irish meal, as well as plenty of Harp, Guinness and Irish whiskey, and a room decorated with blinking green shamrock-shaped lights.
Parties are not the only place where a theme can be fun and interesting. In fact, when applied to your investing, a theme can be all of that, along with the potential to be lucrative. And thematic ETFs are the most efficient way to do it.
What is a Thematic ETF?
For example, say you’re interested in space exploration, and would like to express that interest through your investments.
Well, you’d be in luck, as there’s an ETF geared toward the theme of space exploration. The Procure Space ETF (UFO) tracks an index of companies involved in various space-related sub-industries, including ground equipment manufacturing, satellite and rocket manufacturing and tracking systems, radio and TV broadcasting, digital imagery and space hardware.
UFO is a good example of a thematic ETF. Theme ETFs differ from sector ETFs in that they offer more targeted exposure to very specific industries or even sub-industries, while filtering out broad-sector stocks that don’t apply to the theme.
For example, the S&P 500 communications sector includes Match.com (MTCH), Disney (DIS), T-Mobile (TMUS) and Alphabet (GOOG). You can easily see there’s no overarching theme within that group.
But when you slice and dice a very specific industry and track the companies involved, then you can develop a much more targeted way of expressing a theme.
Thematic investing took off during the pandemic, growing to $133 billion in total assets by mid-2021, up from around $27 billion.
A few years ago, I became aware of thematic investing as my asset-management clients were asking for exposure to the nascent cannabis industry. Unfortunately, hype surrounding that industry’s growth swayed many investors to purchase cannabis ETFs like the ETFMG Alternative Harvest ETF (MJ), which tracks an index of companies encompassing medical and recreational cannabis legalization initiatives.
While that still sounds like a compelling story, this ETF has been a laggard, declining 36.32% in the past three years and 18.48% in the past five years.
However, in a recent interview, Luis Berruga, CEO of ETF provider Global X, said new industry classifications by major index providers MSCI and S&P Dow Jones could breathe new life into popular themes such as cannabis and renewable energy.
I recently spoke with Kevin Kelly, CEO of Kelly ETFs, which earlier this year launched three thematic ETFs, focusing on apartments, real estate and gene editing technology. According to the company’s literature, Kelly ETFs “strives to create disruptive exchange-traded funds that offer investors the opportunity to capture highly liquid, pure-play exposure to the best-in-class companies identified in each emerging theme or sector, regardless of geographical location.”
That last part is important: If you are buying into a traditional S&P sector fund, you’ll be limited to the large-cap domestic stocks that comprise the S&P 500. But if you truly want broad exposure to an industry theme, you should expand your investable universe to include small caps and non-U.S. stocks.
For example, the Kelly CRISPR & Gene Editing Technology ETF (XDNA) invests in a passively managed, concentrated portfolio of companies that engage in CRISPR and gene editing technology activities. CRISPR stands for Clustered Regularly Interspaced Short Palindromic Repeats. Yes, that’s a mouthful. In layman’s terms, it’s a powerful genome editing tool that helps researchers alter DNA sequences to modify gene function.
As you can see, that focus is much more narrow than you’d find in a simple biotech industry ETF.
Thematic ETFs Picking Up Steam
This week, asset manager Brown Brothers Harriman released its 2022 Global ETF Investor Survey. The survey examined attitudes toward thematic ETFs.
According to the study, global thematic ETFs saw net inflows of $80.5 billion last year.
“Last year, BBH noted that thematic ETFs were no longer a fad and we see that notion continuing this year: 85% of global ETF investors said they plan on increasing exposure to thematic ETFs and 38% of investors plan to allocate 11-20% of their portfolio to thematics, an increase of 4% from 2021,” the researchers wrote.
BBH went on to note that technology-focused thematic ETFs, including cloud computing and cybersecurity products, garnered the most interest, with 64% of investors surveyed saying they planned to add these ETFs to their portfolios this year.
BBH also cited significant interest in robotics/artificial intelligence, healthcare and autonomous and electric vehicles. Cryptocurrency is also popular. Cannabis is currently seeing muted interest, almost certainly due to poor performance of equities in that industry, as noted above.
If you opt to add thematic ETFs to your portfolio, or purchase one or more as trades, understand how they fit into your overall allocation and what risk levels they add. In my experience, it’s probably best to add a thematic ETF outside your long-term retirement allocation, and treat it as a way to boost return. Likewise, if your ETF delivers a disappointing return, it won’t put your financial goals at risk.
And if you need help selecting an ETF – thematic or otherwise – I encourage you to subscribe to my brand new Cabot ETF Strategist advisory, where I have a portfolio full of ETF recommendations to provide you with a well-rounded, diversified portfolio.
Do you own any thematic ETFs? Tell us about them in the comments below.