It’s being tagged as the third wave of Exchange Traded Fund Investing.
First came the plain vanilla funds that mirrored the best known indices, then came the funds created to capture action in sectors such as fixed income. Now the third wave has arrived in the form of thematic funds and when they come right, they pay off handsomely.
They work in the same way as any ETF - a basket of stocks is created and sold to investors as a single listed product with low fees. But thematic funds concentrate on megatrends - secular growth themes that are expected to last for many years such as the rush for battery metals to power electric cars
No surprise then the best performing ETFs just now are thematic funds that have targeted stocks that feed into the boom in new technologies.
It’s as an alternative path for the small investor in specialist markets that these new style ETFs should be at their best. Certainly many small investors may have been frustrated by the sensational returns offered in technology stocks that can be both difficult to select or even impossible to obtain on the ASX.
Among the top ETFs in the past 12 months with returns ranging from 35 per cent to 60 per cent are products such as ETFS Battery Tech and Lithium (ACDC), BetaShares Asia Technology Tigers (ASIA), ETFS Biotech CURE, BetaShares Global Robotics RBTZ and ETFS Robo Global ROBO.
These thematic returns, which are multiples of the returns being offered by the traditional ETFs over the same period, are changing the very nature of the ETF sector from a hands-off mirror model to something that is considerably closer to active management.
“We are going to see more of these third wave funds in the years ahead,” says Ilan Israelstam, head of strategy at BetaShares. “Investors are increasingly understanding this style of ETF investing and the industry is responding.”
Certainly the second half of 2020 saw ETF managers launch funds that would have been inconceivable only a few years ago.
VanEck for example, announced its Esports ETF named ESPO in September aimed at pure-play video gaming and Esports companies.
For the more niche ETFs, management fees can be relatively higher - up to 0.6 per cent against 0.2 per cent or less for the biggest ETFs - but those fees are still invariably lower than managed funds that are ultimately offering the same service but charging for stock picking.
Moreover, though some of these specialist ETFs have only a modest amount of funds under management compared to the giants of the sector - Vanguard has $7bn in its Australian Shares Index fund (VAS) - the newer funds are growing fast.
Among the top performing thematic funds - The BetaShares Asian Tiger Technology fund - has $617m under management.
As the industry evolves, the institutional investment market steadily accommodates the sector’s newer creations with many major super funds now offering ETFs as a direct investment option - AustralianSuper, for example, offers its members around 50 different ETFs to choose from.
For the thematic ETF sector, the next strategic target will be the launch of an ETF that can capture the demand for crypto products such as Bitcoin. Indeed that might be fourth wave.
But as Cliff Man, head of Portfolio Management at ETF Securities suggests, a “crypto ETF” remains some way off as regulators strongly resist allowing the funds to enter this area.
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