The advantages of thematic ETFs

Peter Sleep, who for full disclosure, has been a client and a friend for many years, wrote a recent article entitled “The problems with thematic ETFs” published on Proactive on 10 May 2021. I thought it would be fun to provide a gentle rebuttal and a counter-narrative.

For context, I am co-CEO of HANetf and we are one of the leading providers of thematic ETFs in Europe so you could argue we are bound to provide a positive outlook for thematic investing.

Thematic investing has been around for a long time, historically delivered in mutual fund and investment trusts. But it has moved to another level in recent years, as a key growth area for ETFs as the industry has developed past cheap beta solutions.

ETFs are just an investment delivery wrapper and are not an asset class on their own so any underlying asset can be tracked if it has adequate daily liquidity. This means ETFs quite naturally are venturing past cheap beta to strategies including active management, smart beta, niche exposures and of course thematics.

Peter’s article effectively said people should invest long term and have a balanced and broad portfolio focusing on cheap building block exposures such as broad market US equities and similar in the bond world.

I don’t disagree with that, but I do think there is room in a portfolio for high conviction themes which should bring opportunities for outperformance versus plain beta. For instance Emerging Markets Internet and Ecommerce UCITS ETF (LON:EMQP, NYSEARCA:EMQQ) performance in 2020 was 82.49% versus iShares MSCI Emerging Markets – EEM which was 16.98%. Wow, do I need to say more?!

The secondary argument in the article for using core ETFs is their low cost. Unfortunately, I do believe this is a common flaw in how ETF selection is approached.

Yes, costs are important where there is limited IP in a product and there are plenty of substitutes as there are with core ETFs, however, where the strategy being offered by the ETF is more thoughtful and unique, higher fees can be justified. The above example of EMQQ is a good one as its total expense ratio (TER) is 86 basis points while MSCI Emerging Markets is around 20bps.

However, isn’t after fee performance more important and isn’t it a no brainer to pay an extra 66bps for 65% outperformance?

It’s also clear that the impact of Coronavirus has led to the rule book being thrown out of the window. Many people have compared the pandemic response to being like a war. During wars there is always innovation, and this has been very clearly the case with Coronavirus.

Thematics have responded to these fast-moving trends that core ETFs can’t, and you have seen huge interest and returns from areas such as cloud computing, healthcare innovation, digital infrastructure, and ecommerce.

Having thematic ETFs available such as HAN-GINS Cloud Technology Equal Weight UCITS ETF (), HAN-GINS Indxx Healthcare Megatrend Equal Weight UCITS ETF (LON:WELL) and Global Online Retail UCITS ETF (LON:IBUY) has allowed investors to react to a completely unexpected set of circumstances that didn’t exist before and that low cost, core ETFs didn’t provide.

Without these new thematic ETFs investors would have lost out on significant upside opportunities for their portfolios.

I do agree with Peter that most of the portfolio should be low-cost building block beta ETFs, but there is a strong argument to look at having 15% to 20% invested in long-term megatrends such as the above. I do agree at the periphery, most notably in the US, there are more frivolous thematic ETFs, but most fulfil a role. These more esoteric ETFs can be ignored.

Peter mentioned the Vegan Climate ETF and The Medical Cannabis and Wellness UCITS ETF () and pointed out their largest holdings are diversified businesses that are not specific to these sectors.

This at first glance is a compelling argument. However, what I would argue is these ETFs often have these holdings as what I term as…