What are thematic ETFs?
Thematic exchange-traded funds (ETFs) have become popular in recent years1. The demand is partly due to the rapidly increasing interest in key themes such as disruptive technology, healthcare, demographic changes, urbanisation and environment, social and governance (ESG) investing.
Thematic ETFs are focused on asset classes that are positioned to make the most of these megatrends and themes2. Additionally, ETFs are transparent and present exposure to liquid and tradeable holdings without the pressure of picking each single winning holding and market-timing, as well as access to assets such as listed infrastructure.
How do they work?
Much of the demand for thematic ETFs has been met by passive strategies, which track benchmarks that are specially constructed to give a broad exposure to a particular theme1. The indices are compiled using rules-based stock selection that aims to create an economic linkage to the selected theme.
Thematic equity indices tend to focus on what are often referred to as pure-play stocks – companies whose activities lie within the scope of a particular theme. For example, in a clean energy index, only companies heavily involved in the generation of renewable energy may be included. They may exclude companies that play a role in energy transition, such as those enabling electrification, including electric-vehicle charging.
Thematic equity indices are also often weighted by market cap, or by a simple equal-weighting construction. The growing number of thematic ETFs and the relatively small number of pure-play stocks can result in many funds chasing the same stocks and investing in highly crowded positions.
As such, active strategies are becoming increasingly popular as investors recognise their greater flexibility and the added value they can deliver over and above passive strategies.
Why employ an active approach?
An active approach has much more embedded flexibility in the construction of the ETF portfolio1,2. Active thematic ETFs often have a much broader investment universe, such as the MSCI All Country World Index, which can give access to the full opportunity set of a theme.
Additionally, active portfolio managers can implement investment ideas without being limited to the stock selection and rebalancing rhythms set by index providers. Passive ETFs usually rebalance only every three months and so cannot adapt to changing market conditions as quickly.
Another advantage to active thematic managers is their ability to take a much more granular approach to portfolio construction and give more weight to companies they believe can provide the most impactful and effective exposure to the selected theme, from across the market rather than limited to certain sectors or types of stock.
An active approach to sustainability solutions
An active manager can apply a much broader approach to the theme and select companies from different sectors2. They can also position the portfolio towards different sub-themes and companies depending on the current market dynamics.
According to Trackinsight’s Global ETF Survey 2022, nearly 40% of investors are keen to invest in sustainable ETFs3. Consumers, companies and policymakers are increasingly backing sustainability, and this is creating a powerful investment opportunity2.
Already, there are active ETFs that combine artificial and human intelligence to target the optimal thematic exposure to sustainability themes.
For example, the climate challenge is driving business changes. Greenhouse gases come from a wide variety of areas – energy in industry, buildings, transportation, and agriculture – and present opportunities across the broad spectrum. These include companies in electricity, water and renewables infrastructure and sustainable food or clean water production.
Rapid urbanisation is shaping a new generation of cities and this is presenting opportunities in companies that are developing less carbon-intense forms of construction, including energy efficiency of buildings, as well as investments to upgrade digital infrastructure to improve productivity.
Provided for information only based on market conditions as of date of publication, not to be construed as offer, research or investment advice. Forecasts, projections and other forward looking statements are based upon current beliefs and expectations, may or may not come to pass. They are for illustrative purposes only and serve as an indication of what may occur. Given the inherent uncertainties and risks associated with forecast, projections or other forward statements, actual events, results or performance may differ materially from those reflected or contemplated.
Diversification does not guarantee investment return and does not eliminate the risk of loss.
1. Source: “Thematic ETFs: An active investment approach”, J.P. Morgan Asset Management, 09.12.2022
2. For illustrative purposes only based on current market conditions, subject to change from time to time. Not all investments are suitable for all investors. Exact allocation of portfolio depends on each individual’s circumstance and market conditions.
3. Source: “Global ETF Survey 2022”, Trackinsight, as of end-3Q 2022.
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