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Most thematic exchange-traded funds (ETFs) look good on paper. Through a single trade on ASX, investors get exposure to dozens of companies benefiting from a hot megatrend.
Thematic ETFs are huge in the United States, less so here. Investors can choose from obesity ETFs, video-game ETFs, biblical ETFs, whiskey ETFs, marijuana ETFs and millennial ETFs. Just about any group of global stocks can be turned into an index that can become an ETF.
There are about two dozen global or sector thematic ETFs on ASX. Thankfully, we have few of the exotic or niche thematic ETFs evident in the US or Europe. Most thematic ETFs on ASX are based on global sectors or themes that have low representation on ASX: large tech and pharmaceutical companies, for example.
Care is needed with thematic ETFs. Overseas product issuers have a habit of launching thematic ETFs to cash in on hype around a trend. Headlines abound about an obesity epidemic in the west, so an index of companies working on obesity products and services is created and an ETF launched, for example.
Some investors believe an ETF’s diversification will protect them. But the thematic ETF might comprise fully of overvalued, speculative and lower-quality companies. Simply put, a lot of thinly traded garbage can be packed into a thematic ETF and promoted based on an underlying megatrend.
Then there’s index composition. Investors in a thematic ETF must be confident the issuer has chosen the right global stocks to benefit from the trend. And that these stocks have sufficient liquidity; lower liquidity in the underlying securities can influence the ETF’s bid/ask spread.
Concentration risk is another consideration. A mainstream share market or country ETF might provide exposure to hundreds of stocks. A thematic ETF in a niche area could hold a few dozen stocks, principally because of a lack of highly liquid stocks to include in its underlying index.
Higher fees in thematic ETFs and currency risks (most thematic ETFs on ASX are unhedged) are other factors. Perhaps the biggest risk is investors buying a thematic ETF to gain exposure to a trend without looking at the companies that make up the fund.
Like any product, investors need to do their homework and know what they are buying.
|Useful information: BlackRock’s Blair Hannon outlines the five-step checklist and “golden rule” investors should know before buying an ETF.
Caveats aside, I see some key benefits with ASX-quoted thematic ETFs. They provide diversified exposure to trends that is not available on ASX. Investors who believe in the potential of artificial intelligence, for example, have few ways to back that view via ASX.
Also, there is merit in self-managed superannuation funds and other long-term investors making a small allocation to global thematic-based ideas. An investor who has a multi-year or decade horizon should be thinking about trends that will take years to play out.
Moreover, thematic ETFs, like all ETFs on ASX, are convenient, transparent and generally cheaper than active funds. Owning an ETF that provides exposure to dozens of global robotics stocks is a lot easier than investing in robotics companies directly, provided you are happy with the market return and believe in the merits of passive and active investing.
I favour four sector or thematic ETFs on ASX:
I have had a positive view on HACK since its 2016 launch and written favourably on it a few times for the Switzer Report. It has returned 22% over one year.
HACK provides exposure to 45 global companies developing cybersecurity products and services, mostly in the US. The ETF’s largest exposure is to network giant Cisco Systems.
Cybersecurity is a defining global megatrend as organisations worldwide pour trillions of dollars into combating cybercrime in the coming decade. At a stock level, there will be many more cybersecurity losers than winners, strengthening the case for a diversified approach.
Another of my long-term ETF favourites, IXJ tracks an index of 1,200 global healthcare companies across the biotechnology, pharmaceutical, medical-devices and hospital sectors. IXJ has returned almost 14% annually over the past five years.
The ETF solves a problem for Australian investors. ASX has only a handful of large healthcare companies and some arguably trade at inflated valuations because of their scarcity in this market. Most biotech companies on ASX are too small and speculative for conservative portfolio investors who want exposure.
Long-term investors should have portfolio exposure to the global healthcare sector, given growth prospects as the global population ages, new discoveries are made and as emerging markets spend more on medical treatments as their middle-class consumption booms.
Launched in October 2018 on ASX, VBLD provides low-cost exposure to 143 infrastructure stocks in developed countries. By sector, electricity, railroads and pipelines constitute almost two thirds of the ETF and most of its companies have multi-billion-dollar valuations.
Like healthcare, exposure to global infrastructure should be a consideration for long-term portfolio investors. There is limited choice to invest in infrastructure via ASX, which has a small group of Australia-focused infrastructure stocks and a few listed infrastructure funds. Most of the action in global infrastructure has been in unlisted funds that target institutional investors.
The infrastructure sector has good long-term prospects as the global population grows, emerging markets invest in new infrastructure and developed markets upgrade ageing assets.
Investors who want global technology exposure usually gravitate to the NASDAQ exchange in the US or focus on western companies on other exchanges. Less considered is investing in Asia-based tech companies, even though the region’s tech sector is booming.
Launched last year, ASIA provides exposure to 50 tech companies across Asia, including Alibaba, Tencent and Baidu. The ETF is a play on Asia’s younger tech-savvy population rapidly adopting new tech products and services, and companies in the region benefiting from the trend.
As with healthcare and infrastructure, ASX provides limited exposure to large technology companies. There are several US-focused tech ETFs on ASX but ASIA is the first to focus on tech in that region. Adding more exposure to technology in long-term portfolios is an obvious strategy and including Asia-focused tech can help diversify existing exposures to US tech.
Like other ETFs mentioned in this story, ASIA is unhedged for currency movements, meaning investors need to form a view on our currency’s direction in addition to the underlying securities in the ETF.
ASIA has returned almost 15% over three months but should be considered more speculative given the risks of investing in emerging markets.