Niche ETFs zero in on macro trends

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Want to grow your investment portfolio with whisky and Pernod? There's a niche ETF for that – along with a slew of other exchange-traded funds focused on narrow market segments or themes.

"There are some wild ones," says Brent Vandermeer, a portfolio manager and executive director, private client group, at Vandermeer Wealth Management in Ottawa. "You can pretty much filter down to anything you want."

Close to 2,300 niche or thematic ETFs were launched in the past decade. For investors looking to give their portfolio a boost, these funds can provide a way to earn higher returns – albeit with higher risk as well, so limited exposure is best – than those typically delivered by their broader-based counterparts.

Through niche ETFs, investors can put their money into underlying holdings that are concentrated in a subsector such as gold, or a market segment such as drones.

Or they can chase growth using ETFs built around a theme or idea. For instance, there's State Street Corp.'s SPDR SSGA Gender Diversity Index ETF, which tracks U.S. companies that are leaders in advancing women to management and boardroom positions.

Global X Management Co. LLC in New York offers theme ETFs that focus on millennials, health and wellness, and longevity.

"Thematic investing is identifying powerful macro-level trends and the underlying investments that stand to benefit from the realization of those trends," explains Jay Jacobs, vice-president and director of research at Global X. "The problem is investors frequently try to play themes by either buying individual stocks or by using traditional ETF tools – for example a financial- or industrial-sector ETF – that aren't very precise to the theme."

With niche or thematic ETFs, investors can home in on specific growth areas within an industry or subsector while staying diversified, says Mr. Jacobs. As an example, he points to his firm's Robotics & Artificial Intelligence ETF, which gives investors exposure to 13 industries in nine countries.

"You're getting rid of single-stock risk, because ETFs typically have 30 to 40 stocks," says Sam Masucci, chief executive officer of ETF Managers Group LLC, a company based in Summit, N.J., that helps fund issuers develop and manage unique ETF products. "But you're concentrated enough so if a particular theme like cybersecurity or mobile payments is interesting, then you can take advantage of it."

So can investors who prefer to pick their own stocks get their kicks – and perhaps even better returns – with niche or thematic ETFs? Mr. Masucci thinks so.

"People often hear about a new or emerging industry and then look for the one stock that best represents that industry," he says. "By investing within a portfolio of 30 to 40 stocks, you can benefit financially from the growth of that theme without having to do all that research into finding that one great company."

Ed Lopez, head of ETF product management and marketing at Van Eck Associates Corp., agrees. He says he sees retail and institutional investors using niche or thematic ETFs to figure out which individual stocks merit a bigger position should the theme play out well.

"It can be a very efficient way to add exposure to that thematic until you can determine which stocks you really want," says Mr. Lopez.

But before they jump into niche or theme ETFs, investors should keep in mind that these concentrated products tend to come with more risk and higher management fees than broad-market funds, says Mr. Vandermeer.

It's a good idea to treat niche and thematic ETFs as satellite investments, he adds.

"You can build a better portfolio with these ETFs than by buying a whole group of small-cap stocks," he says. "But remember that you have your core holdings and your satellite holdings, and niche ETFs should be seen as a way of trying to generate [returns] outside the core."

Mr. Jacobs at Global X suggests allocating 10 to 15 per cent of a portfolio's equities portion to thematic investing.

"Themes are inherent growth opportunities," he says. "If you have between two to four themes in your portfolio, that should be more than enough."

Five funds

Looking to try your hand with a themed exchange-traded fund? Consider these five ETFs.

Global X U.S. Infrastructure Development ETF: With the Trump administration promising to spend about $100-billion (U.S.) a year to fix highways, bridges, airports and railways, it may not be a bad idea to invest in companies involved in south-of-the-border infrastructure projects. This fund, launched last month, provides access to companies in electrical components and equipment, construction, engineering, steel, railroads and industrial machinery.

PureFunds ISE Mobile Payments ETF: Hailed as the world's first mobile and electronic payments exchange-traded fund, this fund tracks the performance of such giant financial-services companies as Visa Inc., MasterCard Inc. and PayPal Holdings Inc. along with smaller players such as MoneyGram International Inc. and Square Inc. This fund gives investors exposure to four financial-industry subsectors: processors, infrastructure and software, card networks, and solutions providers.

Ark Invest 3D Printing ETF: In recent years, 3-D printing has made its way into manufacturing, in industries from medical devices to food. Through this ETF, investors can put their money into U.S. and overseas companies involved in 3-D printing hardware and simulation software, computer aided design, 3-D printing centres, scanning and measurement, and printing materials.

VanEck Vectors Gaming ETF: Want to bet on betting? This ETF tracks casinos, casino hotels, sports betting, lottery and gambling services, as well as gambling technology and equipment. The fund has 40 holdings in 16 countries, with the United States, Australia and China accounting for the largest pieces of the pie.

Global X Robotics & Artificial Intelligence ETF: The world is increasingly moving toward industrial automation, robots and self-driving cars. Investors interested in this trend might consider this six-month-old fund, which includes big players such as Mitsubishi Electric Corp. and Fanuc Ltd. With holdings that cover 13 industries in nine countries, diversification is a key attribute of this ETF.