Reasons to Be Wary of Thematic ETFs

Robotics, ESG, artificial intelligence - thematic ETFs are growing in popularity. But investors should look before they leap says Morningstar's Kenneth Lamont

Emma Wall 26 September, 2018 | 7:28AM

 

Emma Wall: Hello, and welcome to the Morningstar series, "Ask the Expert." I'm Emma Wall and I'm joined today by Morningstar Analyst, Kenneth Lamont, to talk about thematic investing.

Hi, Kenneth.

Kenneth Lamont: Hello, Emma.

Wall: So, thematic investing, in particular, thematic ETFs, what are they?

Lamont: Well, a thematic ETF is an ETF which invests in stocks based on a specific theme. For example, artificial intelligence or robotics or ecommerce. The ones I've just listed are all tech funds, but they are not limited to tech. They could be social themes such as aging populations or environmental themes such as water or alternative energy.

Wall: Is it fair to say that tech has probably gained the most traction. There's a lot around at the moment about artificial intelligence, robotics and that thought of investment.

Lamont: Well, tech is the big driver of our age. So, it's unsurprising that a lot of these big structural changes, which are being tracked, are in tech. Specifically, the robotics funds have really caught the imagination in the last couple of years.

Wall: But as you say, it's not just limited to tech. It branches across environmental and indeed, even gender.

Lamont: Absolutely. There's a fund which selects stocks on gender characteristics. Generally, funds will use revenue sources and actually committee approaches where they meet and actually decide how pure an individual stock is in their exposure to the underlying theme, for example.

Wall: So, the key question is, what should investors be wary of before jumping on this bandwagon?

Lamont: Well, as always, there's buyer beware, particularly when you step away from main market cap vanilla products. But primarily, you should invest in a robust strategy. These products are quite tricky to evaluate. They have little or no often performance history. And in fact, the theme by its nature is yet to play out. And even after the fact, they are quite difficult to assess in terms of performance because often they have no direct peers or few direct peers with which to evaluate.

Wall: It's also worth considering how they fit into a portfolio, isn't it? Because these should only have to be a very niche holding in someone's portfolio?

Lamont: Absolutely. They are tricky products all round. The narrative makes them very attractive. But when you actually sit down and ask yourself how you want to fit them into your portfolio, you have to understand the individual risk and return drivers associated with that product.

Wall: Kenneth, thank you very much.

Lamont: Thank you, Emma.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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Emma Wall

Emma Wall  is Senior International Editor for Morningstar