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The themes driving the growth of ETFs

Spurred by the booming Exchange Traded Funds market, thematic investing has driven a proliferation of products

As investors look to reap returns from demographic, lifestyle and technology changes, thematic investment is picking up pace. While some themed Exchange Traded Funds (ETFs) have produced stellar returns, asset managers must be wary of marketing niche products that may offer more risk than reward.

Investors warming to the theme

Key insights

  • Thematic products occupy a small but rapidly growing segment of the ETF market
  • Investor demand for exposure to demographic changes, cybersecurity and healthcare has sparked a proliferation of niche ETFs
  • Thematic investment has been warmly embraced by creative ETF issuers but asset managers should be wary of high-risk pure-plays for small or less well defined industries

The global boom in the USD 4 trillion ETF market has been mirrored in Canada, where ETF assets under management reached CAD 147 billion at the end of 2017, an increase of more than 700 percent over the past decade, according to the National Bank of Canada. Thematic products retain only a small slice of the ETF market, but the segment has grown exponentially in recent years. At the end of 2016, there were 447 thematic ETFs available globally, up from 183 in 2012, with assets under management soaring from USD 41.4 billion to 77.9 billion.1 With major asset classes and industries already well serviced by large and established ETF issuers, new and smaller entrants seeking a share of this booming market have helped drive the growth of niche funds to meet more specific investor demands.2

Tapping the millennial spend

The millennial cohort, aged between 18 and 35, has collectively become a theme, with investors keen to tap into their increasing spending power. By 2020, global millennial wealth could stand at USD 24 trillion, driven by inheritance, entrepreneurial activities and income growth, according to Deloitte.3

ETF providers have issued a number of thematic products that focus on millennials' spending habits in technology, social media and leisure

Some 75 million millennials living in the United States spend more than USD 65 billion a year.4 ETF providers have issued a number of thematic products that focus on millennials' spending habits in technology, social media and leisure. New York-based fund manager Global X issued its "Millennials Thematic ETF" in 2016, investing in retail and entertainment sectors, as well as prominent tech and media companies such as Facebook and Netflix. Principal Funds, another US fund manager, also launched a millennial-focused ETF, which includes holdings in the video game group Electronic Arts and travel website Priceline.5

Locking in cybersecurity

Cybersecurity is becoming ever more important as the world digitizes, with increased connectivity and code taking greater control over everything from cars and phones to sophisticated military defence systems. Defending code from hackers and 'cyber-terrorists' has become a significant industry, prompting ETF providers to create products focused on cybersecurity firms that benefit from market-moving events such as major network breaches and data theft incidents. One European-domiciled ETF marketed to investors seeking pure-play exposure to an increase in demand for cybersecurity is the ETFS ISE Cyber Security GO UCITS ETF, which tracks the performance of the ISE Cyber Security UCITS Index. It currently has USD 327 million in equity and a one-year return of around nine percent, according to Bloomberg data.6

Cybersecurity is becoming ever more important as the world digitizes

Evolve Funds in Canada recently launched its Evolve Cyber Security Index ETF (CYBR), which trades on the Toronto Stock Exchange.7 The ETF tracks the Solactive Global Cyber Security Index and is the country's first ETF investing primarily in global cybersecurity companies.

A number of cybersecurity-themed ETFs have also listed on Nasdaq and the New York Stock Exchange in recent years, underlining the anticipated growth in the sector.

Long-term focus for health and wellness ETFs

Advances in healthcare, a growing population and increasing longevity are all feeding into alluring investment avenues for asset managers who favour a long-term focus. People may be living longer but perhaps not in a healthy fashion, with lifestyle diseases becoming more prevalent in developed countries. The theme has generated some creative ETFs including 'SLIM', an obesity-focused ETF issued by Janus Henderson Investors. Companies in its portfolio include New Zealand's Fisher & Paykel Healthcare, which creates products such as masks for sleep apnea.8 The iShares Healthcare Innovation UCITS ETF is another themed investment that tracks companies focused on advancing specific aspects of the healthcare industry, including drug treatments, patient care, and diagnostic tools.9

On a different tack, Canada's move to legalize cannabis in 2018 is sprouting ETFs focused on companies serving medical and recreation markets for the drug. Evolve Funds announced in January 2018 that it had filed a preliminary prospectus with the Canadian securities regulator for the country's first actively managed marijuana ETF (SEED).10

Mining investment gold in the 'silver economy'

Increasing longevity and declining fertility rates should see the share of people aged over 60 reach 22 percent of the world's population by 2050, versus 12 percent today, according to United Nations data.11

As with millennial-themed investments, issuers are also producing ETFs that focus on the specific needs of seniors

The wealth of the baby boomer generation is well-documented and the spending power of over-60s could reach USD 15 trillion by 2020.12

As with millennial-themed investments, issuers are also producing ETFs that focus on the specific needs of seniors, ranging from investments in travel companies specializing in cruise-ship tourism to care firms for the elderly. One example is the iShares Ageing Population UCITS ETF, which tracks companies that own or operate senior living facilities, provide nursing services or are engaged in biotech research for age‐related illnesses.13

Risks in niche investing

A number of thematic ETFs have produced impressive, double-digit returns for investors, but some have struggled to generate sufficient traction in an increasingly crowded market. There have been some notable failures. In October 2017, Global X closed seven of its funds after none managed to obtain more than USD 8 million in assets.14

Investors are arguing that niche ETFs may service industries that are too small or not properly defined, or may be 'gimmicky' and vulnerable as passing fad.15 ETFs intrinsically linked to excessively narrow segments may also struggle to produce sufficient liquidity to inspire investor confidence. Mindful of more conservative investors, ETF managers continue to issue "balanced" products that offer a less expensive alternative to mutual funds. Three new ETFs from Vanguard ("Conservative ETF Portfolio", "Balanced" and "Growth") began trading on the Toronto Stock Exchange in February 2018 and combine investments in the company's own bond-focused ETFs with shares of domestic and global companies.16

The demand for transparent, tax-efficient investments with exposure to demographic, lifestyle or technological changes provides alluring opportunities for creative ETF issuers but asset managers should be mindful that the risks of limited-exposure products may outweigh the returns.


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Sources

  1. Financial Times (September 7, 2017) Fancy Investing in a Theme?
  2. Marketwatch (April 18, 2017) Are Thematic ETFs Gimmicks or Smart Strategic Plays?
  3. UBS (June 22, 2017) Millennials: The Global Guardians of Capital
  4. Ibid. Financial Times
  5. Ibid. Financial Times
  6. Bloomberg (October 2017) ETFS ISE Cyber Security GO UCITS ETF quote
  7. The Globe & Mail (July 19, 2017) Canada is now getting its own cyber security and gender diversity ETFs
  8. Ibid. Financial Times
  9. ETF Strategy (September 13, 2016) iShares Launches Four Global Thematic ETFs
  10. Evolve ETFs (January 12, 2018) Press Release
  11. World Health Organization (September 2015) Ageing and Health Factsheet
  12. Forbes (December 16, 2016) Longevity
  13. ETF Strategy (September 2016)
  14. ETF.com (September 25, 2017) Global X to close 7 ETFs
  15. Ibid. Are Thematic ETFs Gimmicks or Smart Strategic Plays?
  16. The Globe and Mail (February 1, 2018) Investing giant Vanguard launches 'one-ticket' solution ETFs