There Are So Many Thematic ETFs Out There. So How Do You Know Which To Choose?

There Are So Many Thematic ETFs Out There. So How Do You Know Which To Choose?
Reda Farran, CFA

over 2 years ago5 mins

  • It has never been easier to incorporate thematic investing into your portfolio thanks to a huge selection of thematic ETFs.

  • The best way to decide on a theme is to filter a list of ETFs sorted by theme and pick from there – that way you can guarantee there are ETFs available to play that theme.

  • If you have a few ETFs exposed to the same theme, pick the one with the narrowest focus and purest exposure to the theme, as well as making sure it’s highly liquid, low cost, and its price is in an upward trend.

It has never been easier to incorporate thematic investing into your portfolio thanks to a huge selection of thematic ETFs.

The best way to decide on a theme is to filter a list of ETFs sorted by theme and pick from there – that way you can guarantee there are ETFs available to play that theme.

If you have a few ETFs exposed to the same theme, pick the one with the narrowest focus and purest exposure to the theme, as well as making sure it’s highly liquid, low cost, and its price is in an upward trend.

Thematic investing – investing in long-term trends that can change entire industries – is becoming more and more popular. But when there are so many thematic ETFs to choose from, it’s also becoming more and more difficult to filter out the good from the bad. So here’s how to do just that.

How do you choose a theme?

The first question to ask yourself is which themes you’re interested in investing in. The best way to do that is to filter a list of ETFs sorted by theme and pick from there – that way you can guarantee there are the right ETFs available.

Lists like this one and this one, where you can click on any of the themes to see all the ETFs relating to it. You could also explore thematic ETFs offered by specific providers like iShares, Global X, and ARK Invest, or even browse through comprehensive lists of all currently available thematic ETFs like this one.

How do you choose a thematic ETF?

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 there are five factors you’ll want to look at:

1. Clarity of the theme

An ETF focused on a narrow, well-defined theme is better than one that’s broad in nature and is too diversified as a result. For example, an ETF focused on clean energy that only invests in renewable energy stocks is preferable to a climate change ETF. The latter, after all, is broad and can 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 are predominantly invested in “pure-play” companies heavily exposed to the theme in question. In contrast, you’ll want to avoid those invested in companies that are only tangentially exposed to the theme and/or only generate 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), the ARK Space Exploration ETF (ticker: ARKX), and the SPDR S&P Kensho Final Frontiers ETF (ticker: ROKT). After digging 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 are debatably 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 what its top holdings are.

3. Liquidity

You’ll want to 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 that just wanted to jump on the thematic investing bandwagon have created new products that barely trade or are very small in size. To assess liquidity, compare the ETFs’ total assets under management (AUM) and average trading volume. You can find this by searching the ETF on websites like ETFdb.

Let’s say you’re interested in the fintech theme and came across the Simplify Volt Fintech Disruption ETF (ticker: VFIN). The screenshot below is taken from ETFdb’s stock profile tab after searching for and selecting VFIN.

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

This ETF only has $2.6 million in AUM and, on an average day, only 3,200 of its shares change hands, most recently at a price of $11 per share. So with just $35,000 worth traded every day, VFIN is rather illiquid. So if you wanted to invest $10,000, the price is almost guaranteed to climb as you buy given that your investment would represent almost 30% of its daily traded value. You can 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 – which could spell disaster in the event of a crash.

So in this case you’re better off looking at other fintech ETFs like the ARK Fintech Innovation ETF (ticker: ARKF), which has an average daily traded value of more than $50 million.

4. Cost

You can measure this by an ETF’s expense ratio, which you can see by again looking at the ETF’s profile page on ETFdb. The ARKF ETF, for example, has a relatively high expense ratio of 0.75%. 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 tracking the same theme.

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) if the trend turns downwards. 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 = uptrend, and negative = downtrend.

That’s important because investor sentiment towards different themes is constantly changing. After the pandemic-induced crash in early 2020, for example, cloud computing stocks – benefitting from the new working-from-home paradigm – started a very strong rally. And in late 2020, 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, helps you be invested in the right theme at the right time.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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