28 BARRON’S August 3, 2020
FUNDS
Year to date, 90 of 129 thematic ETFs beat the
S&P 500, returning 17% on average; 48 of them
outran thebest-performing sector, technology.
Diversification Works,
ButSoDoThese
Niche, Thematic ETFs
I
nvestors are often told that
the golden rule of investing
is diversification. Sometimes,
though, it pays to make a tar-
geted bet. That has been the
driving force behind thematic
exchange-traded funds: These
niche funds grew three times as fast
as the rest of the ETF industry in the
second quarter.
Thematic ETFs typically focus on
long-term, societal trends, such as dis-
ruptive technologies, climate change,
or shifting consumer behaviors. Some
of the most popular themes include
cloud computing, robotics, and electric
vehicles, as well as the gig economy,
e-commerce, and clean energy.
These are hot topics, for sure. And
they’re hot stocks: Year to date, 89 out
of the 129 thematic ETFs on the market
beat the S&P 500 index, returning 17%
on average; 47 of them even outran the
best-performing sector, technology.
Thanks to both strong inflows and
market-beating performance, thematic
ETFs saw their assets increase 65% in
the second quarter, more than three
times the broader ETF industry’s 19%
growth, according to data from Global
X, which offers 20 thematic ETFs. Five
years ago, there were just 40 thematic
ETFs with $5 billion in assets. Today,
there’s $41 billion in these ETFs.
The Covid-19 pandemic, mean-
while, has disrupted how people live
and how companies are run—possibly
forever. More than ever, investors
have become aware that the future
might look very different from today,
says Matthew Bartolini, State Street’s
head of SPDR Americas research, and
they are interested in the companies
that could be the biggest beneficiaries.
“This acceleration is likely to remain
very sticky beyond Covid-19,” says Jay
Jacob, head of research and strategy
for Global X.
For a theme to be investible, there
must also be a large enough address-
able market, and sufficient companies
with products and services to address
that market. Some industries, while
promising, are still too nascent. True-
Mark Investments, a new ETF firm
founded just a year ago, closely moni-
tors venture capital and private equity
to identify emerging public companies
for its $12 millionTrueShares Tech-
nology, AI & Deep LearningETF
(ticker: LRNZ).
Despite thematic ETFs’ impressive
returns, investors should proceed
with caution. Most of these ETFs are
quite small; More than half of the 129
funds have less than $100 million in
assets, though a dozen have crossed
the $1 billion mark. Most are also
fairly new; just 16 funds have a 10-
year track record, mostly in clean en-
ergy and natural resources; 75 haven’t
been open for three years. They’re also
a bit more complicated to build, since
they’re either actively managed or
track a customized index—and that
means they can be more costly. The
average expense ratio for this group is
1.05%, while the broader ETF indus-
try charges just 0.67%.
Two of the largest thematic ETFs,
the $6.1 billionARK Innovation
(ARKK) and $4.7 billionFirst Trust
Cloud Computing(SKYY), have
returned 61% and 29%, respectively,
year to date, beating the $32 billion
Technology Select Sector SPDR
(XLK)’s 18% return. The $1.6 billion
ARK Genomic Revolution(ARKG)
is the largest thematic ETF focused on
health-care innovation; it has returned
63% year to date, ahead of the $24
billionHealth Care Select Sector
SPDR(XLV)’s 5% return.
Thematic ETFs don’t perform like
their sector’s ETFs because they are
actually quite different. Most the-
matic ETFs have very little overlap
with traditional sector funds. They
usually have fewer stocks, and tend
to own more small and international
stocks—sometimes across multiple
sectors. The 39 holdings in ARK In-
novation, for instance, have an aver-
age market cap of $8.4 billion,
whereas the technology SPDR, with
72 stocks, has an average market cap
of $339 billion. The ARK fund also
has 13% in international stocks, and
the SPDR, virtually zero. Only two of
the ARK fund’s holdings—Xilinx
(XLNX) andAutodesk(ADSK)—
also belong to the SPDR tech ETF,
and due to their smaller size, they
account for only 1% of the SPDR
tech. Similarly, only three out of the
39 stocks that the ARK Genomic Rev-
olution holds are also in the health-
care SPDR, making up just 4% of the
latter’s portfolio.
B
ecause thematic ETFs are so
specific, even those with
similar names can turn out
to have little in common. The
same theme can be interpreted differ-
ently, and various methods—from
fundamental to quantitative—are
used to select and weigh stocks.
Investors who still want some di-
versification might be better served
with equal-weighted funds, especially
those with a higher number of hold-
ings. The $2.4 billioniShares Expo-
nential Technologies(XT) and the
$1 billionSPDR Kensho New Econ-
omies Composite(KOMP), for in-
stance, have about 200 and 400 hold-
ings, respectively, and both are largely
equal-weighted, with minor modifica-
tions. “This is really about delivering
thematic beta,” says Jeff Spiegel, head
of iShares megatrend and interna-
tional ETFs at BlackRock, “It’s not
about having a view that one particu-
lar company will be the winner of the
theme. It’s much more about getting
exposure to a range of firms.”
Many thematic ETFs are more
concentrated, however. These can be
more pure plays, but only as a supple-
ment to an otherwise well-diversified
portfolio. Ark Financial’s and Global
X’s ETFs, for instance, have fewer
holdings, often less than 50, and the
weighting depends on either active
managers’ conviction or how well the
stocks have been performing. “The-
matic investing, if done right, should
be more concentrated,” says Global X’s
Jacob, “You own the companies that
are best positioned to benefit from the
materialization of a trend.”B
By Evie Liu
Leading Themes
Thematic ETFs typically focus on the hottest trends—and stocks. Their returns are impressive, but proceed with caution.
Fund / Ticker Expense Ratio AUM ($mil) YTD Return 3-Yr Return*
ARK Next Generation Internet / ARKW 0.75% 1,914 69.8% 44.9%
ProShares Online Retail / ONLN 0.58 234 65.9 N/A
Genomic Revolution / ARKG 0.75 1,617 62.9 38.6
WisdomTree Cloud Computing / WCLD 0.45 644 62.0 N/A
Amplify Online Retail / IBUY 0.65 755 61.3 31.1
ARK Innovation / ARKK 0.75 6,137 60.6 41.5
O’Shares Global Internet Giants / OGIG 0.48 356 54.6 N/A
Fintech Innovation / ARKF 0.75 330 48.2 N/A
Video Gaming and eSports / ESPO 0.99 367 47.3 N/A
Global X Video Games & Esports / HERO 0.50 161 47.1 N/A
Note: Data as of July 30 , 2020 ;* annualized;N/A means the funds are launched less than threeyears ago. Sources: Global X,Morningstar