How To Find The Best ETF For Your Investing Theme

Everyone knows that a flash-in-the-pan investment can deliver some hot returns, but get in at the wrong time and it can leave you badly burned. That’s why thematic investing – investing in long-term trends that can change entire industries – is becoming more and more popular. Problem is, with so many thematic ETFs to choose from, it’s also becoming increasingly difficult to tell the good from the bad. So here’s how to do just that.

How do you choose a theme?

First, you’ll want to decide which themes to invest in. The simplest way to do that is to grab a list of ETFs that are already sorted by theme – that way you can guarantee there are ETFs to match.

Lists like this one and this one are handy because they allow you to click on a theme and see a lineup of all the ETFs that relate to it. You could also explore thematic ETFs offered by specific providers – iShares, Global X, or ARK Invest, for example. Or you can browse through a comprehensive list of all currently available thematic ETFs, like this one.

How do you choose which ETF to go with?

Once you’ve picked your theme, it’s time to choose an ETF. This, it has to be said, is more art than science, but you can make an informed decision by looking at these five factors:

1. Clarity of the theme

An ETF that’s focused on a narrow, well-defined theme is better than one that’s broad in nature and overly diversified as a result. For example, a clean energy ETF that invests exclusively in renewable energy stocks is preferable to a climate change ETF. The latter, after all, is broad and could include hundreds of stocks, from companies in renewable energy and batteries to electric vehicles and agriculture. Investing in so many companies dilutes the focus on the clean energy theme.

2. Purity of exposure

You’ll want to select ETFs that predominantly invest in “pure-play” companies – the kind that are heavily exposed to the theme itself. And you’ll want to avoid the ones that invest in companies that are only tangentially exposed to the theme or generate just a small portion of their revenue from it.

Take, for example, space ETFs. Investors currently have three main ones to choose from: the Procure Space ETF (ticker: UFO; expense ratio: 0.75%), the ARK Space Exploration ETF (ARKX; 0.7%), and the SPDR S&P Kensho Final Frontiers ETF (ROKT; 0.45%). If you dig into them, you’ll notice ARKX invests in companies “benefitting from technologically enabled products and/or services that occur beyond the surface of the Earth”. In other words, the ETF includes plenty of stocks that arguably aren’t in the space market at all, including agricultural machinery makers and ecommerce companies. ROKT isn’t a pure-play space ETF either: it invests in deep-sea exploration companies.

The best way not to get caught out by these impostors is to go over the ETF’s investor information with a fine-tooth comb and assess how the ETF provider defines the theme, its criteria when selecting companies, and its top holdings.

3. Liquidity

Depending on how your theme-based ETF performs, there’s a chance you’ll want to buy more of it – but there’s also the chance you’ll want to dump it. So, ask yourself how easy it is to buy in or sell out without causing big shifts in price (or paying too much in trading costs). Some ETF providers have only recently jumped onto the thematic investing bandwagon with new products that barely trade or are very small in size, and that can add a layer of risk. To assess liquidity, compare the total assets under management (AUM) and average trading volumes of the ETFs. You can find this by searching websites like ETFdb.

Let’s say you’re interested in the cybersecurity theme and came across the ProShares Ultra Nasdaq Cybersecurity ETF (ticker: UCYB; 0.98%). The screenshot below is taken from ETFdb’s stock profile tab after searching for and selecting UCYB.

UCYB’s trading stats. Source: ETFdb.com.

This ETF has just $2.1 million in AUM and, on an average day, only 517 of its shares change hands, most recently at $31 per share. So with roughly $16,000 worth of the fund traded every day, UCYB is rather illiquid. If you wanted to invest, say, $5,000 in the ETF, its price is almost guaranteed to climb as you buy, given that your investment would represent around 31% of its daily traded value. You could buy a small amount every day over a few consecutive days, sure, but that means you’d have to do the same if you ever wanted to exit your investment – and that could spell disaster in the event of a crash.

So, in this case, you’re better off looking at other cybersecurity ETFs like the First Trust NASDAQ Cybersecurity ETF (CIBR) or the iShares Cybersecurity & Tech ETF (IHAK), which have average daily traded values of more than $17 million and $2.5 million, respectively.

4. Cost

You can measure this based on an ETF’s expense ratio, which you also can find on the fund’s profile page on ETFdb. The CIBR ETF, for example, has a relatively high expense ratio of 0.6%. Thematic ETFs tend to have higher expense ratios than simpler ETFs that track popular stock market indices, so it’s important to make sure you’re not overpaying for an ETF if there’s a cheaper alternative doing the same thing. IHAK, for example, has an expense ratio of just 0.47%.

5. Price trends

Knowing whether the ETF – and, by extension, the theme – is in an uptrend or downtrend can help you better time your investment decisions, buying when the ETF is on the up and avoiding (or selling) it when the trend turns downward. You can do this using a simple technical indicator such as 12-month price momentum, which measures the ETF’s percentage price change over the preceding 12 months. Positive means there’s an uptrend, and negative means there’s a downtrend. Another approach is to see whether the ETF’s price is currently above its 200-day simple moving average, which indicates an uptrend (a price below the average indicates a downtrend).

That’s important because investor sentiment is constantly changing – even when it comes to long-term themes. After the pandemic-induced crash in early 2020, for example, cloud computing stocks, which benefited from the new working-from-home paradigm, started a very strong rally. And later that same year, after the green-leaning Democratic Party won the US presidential election, clean energy stocks went on an absolute tear. Including a momentum indicator in your ETF selection criteria, then, can help make sure you’re invested in the right theme at the right time.