While some have done well, disappointing results and flip-flopping fund objectives highlight risks
Considering the differentiated impact the COVID-19 pandemic has had on businesses and industries, there’s certainly reason to believe in the viability of thematic investing. But judging by the history and lacklustre performance of certain products, it’s probably best not to go all in.
So far this year, the U.S. marketplace has seen 198 ETF closures, according to data from FactSet. Among them are thematic funds that focus on legislative policies (PLCY), organic food (ORG), and sustainable investing (ESGW), each of which represented cases where the narrow theme of a fund never flourished, or didn’t do so fast enough for the fund to reap the benefits.
“[R]isk greatly increases the narrower you get when it comes to investing themes, so it can be a hit or miss proposition,” said Ron DeLegge, founder and chief portfolio strategist at ETFguide, in a recent article on Financial Advisor.
DeLegge pointed to several thematic success stories, including the Direxion Work from Home ETF (WFH). A multi-theme fund covering cloud technology, cybersecurity, remote communications, and online work collaboration, it has amassed almost US$122 million in assets since launching in June this year, making it among the best thematic funds by asset growth for 2020.
Success can also come over a longer time period, such as was the case for ARK Invest’s product line concentrated on disruptive innovation. Since 2014, DeLegge said, ARK has taken in US$15 billion in assets across seven thematic ETFs.
But some funds turn out to be cautionary tales of hype. He pointed to the ARK 3D Printing ETF (PRNT), whose portfolio of 53 stocks has failed to deliver exciting results. It has lagged significantly behind the SPDR S&P 500 ETF Trust (SPY), notching a return of just 29% over the past five years in contrast to 89.5% for SPY. The ETFMG Prime Cybersecurity ETF (HACK) has gained 91.4% over that same period, barely beating out the benchmark-tracking SPY.
“In other cases, ETF providers can suddenly backtrack on themes by changing a fund’s objective,” DeLegge said. He cited the PureFunds Drone Economy Strategy ETF (IFLY), introduced in March 2016; it has since shifted to include Boeing and Honeywell, large-cap companies for which drones represented a minimal part of their revenue. As of April 2020, IFLY’s ticker symbol and strategy were retired following staid interest in drone technology.
With those cases in mind, DeLegge offered some lessons with respect to thematic ETF investing. One is to carefully monitor the thematic ETFs that go into a portfolio; from a risk and diversification perspective, multi-theme funds are typically preferrable to single-theme strategies.
It also pays to check the underlying holdings of an ETF and compare it to other investments within the portfolio. The exercise might be tedious, but it could prevent needless duplication in stock holdings or costly investment in large-cap funds masquerading as thematic strategies.
He ended with a friendly reminder that because of their concentrated holdings, “thematic ETFs are usually best used as satellite positions that complement much larger core positions in broadly diversified funds.”
