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AI, health care, clean tech and infrastructure are among the trends that thematic ETFs aim to capture for investors.Getty Images

Thematic exchange-traded funds (ETFs), which invest in specific trends such as artificial intelligence (AI) or clean tech, were themselves a hot option a few years ago.

“Many moonshot themes saw billions of dollars of inflows in the pandemic-driven, ultralow interest-rate market recovery,” says Daniel Straus, managing director of ETFs and financial products research at National Bank of Canada Financial Markets in Toronto.

A report from Global X shows assets under management (AUM) for thematic ETFs peaked at nearly US$150-billion at the end of 2021. For the past several months, the collective AUM has declined by about $70-billion.

That may present an opportunity for investors who believe in the long-term viability of the trends thematics aim to capture. A pullback means more attractive valuations, says Lara Crigger, New Orleans-based editor-in-chief of VettaFi.com, which tracks thematics.

She says people typically invest in them after strong returns, only to sell at a loss when short-term performance fails to match expectations. Some themes are still garnering interest, such as AI. A lot of that hype is driven by big tech conglomerates like Microsoft Corp. MSFT-Q, but Ms. Crigger says the real movement will likely come from smaller, pure-play companies.

For AI or any thematic, she says investors seeking to capture the upside potential should look for three characteristics:

  • An ETF with a concentrated portfolio: 75 holdings or less. Broad diversification is ideal for ETFs covering large markets such as U.S. equities. But ETFs with smaller portfolios often provide better exposure to themes.
  • An alternative index weighting to market-cap. Again, the idea is to reduce the effect of large firms and augment exposure to smaller, pure-play companies, Ms. Crigger says.
  • An ETF with reasonable management expense ratios (MERs). Many thematics command higher costs due to more complex portfolio construction. “If the price tag really gives you pause, don’t waste your time,” she says.

A product that checks all these boxes is the Global X Robotics and Artificial Intelligence ETF BOTZ-Q with 42 holdings. Its 0.69-per-cent MER is higher than some competitors, but the BOTZ index construction favours smaller, pure-play companies while limiting the aggregate weighting of its largest holdings to 40 per cent of the portfolio.

Although smaller portfolios present concentration risk, highly focused thematic ETFs still provide better risk-adjusted exposure to new trends with greater long-term potential than stock picking. “In the early days of the Internet, I remember buying Netscape over Google, so I got the story right but implementation was wrong,” says Brent Vandermeer, senior portfolio manager with CrossPoint Financial at iA Private Wealth Inc., in Ottawa. “That’s the same issue today with AI.”

Similarly, clean energy is a long-term theme where picking stocks can prove challenging. That makes options like the iShares Global Clean Energy ETF ICLN-Q worth a closer look. “ICLN was one of the most popular ETFs during the pandemic when interest rates were near zero,” Mr. Vandermeer says.

Today, its price is less than half of its peak, potentially presenting an entry point for investors believing in the theme long-term.

The Inflation Reduction Act, passed last year in the United States, is expected to inject hundreds of billions of dollars into clean energy, possibly serving as a long-term tailwind for ICLN and similar funds, Mr. Vandermeer adds.

Infrastructure is another thematic subset gaining interest. “Anybody in big cities can see how infrastructure is crumbling,” Mr. Straus says. That calls for large-scale investments.

Some longer-running ETFs in this space have strong track records, including BMO’s Global Infrastructure Index ETF ZGI-T. It has a 10-year annualized return of nearly 9 per cent, although it’s down about 6 per cent in the past year.

Infrastructure ETFs are receiving more interest because it’s a defensive sector. Health-care ETFs for the same reason, Ms. Crigger says. “People always need health care, recession or not.”

Funds such as Invesco’s S&P 500 Equal Weight Health Care ETF RSPH-A have drawn significant interest on VettaFi.com recently, she says. The ETF has an alternative index weighting and a 0.4 per cent MER, which is “pretty cheap” for a thematic ETF.

Mr. Vandermeer says it’s worth asking whether this exposure is worth the cost, given broad-based ETFs tracking the S&P 500, which includes health-care stocks, have MERs of five basis points or less. “You need to ask whether you’re buying a distinct theme with different performance from the broad index, or if you’re essentially buying similar performance at a higher cost.”

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 19/04/24 3:27pm EDT.

SymbolName% changeLast
MSFT-Q
Microsoft Corp
-1.27%399.12
BOTZ-Q
GX Robotics & Artificial Intelligence ETF
-2.02%28.65
ICLN-Q
Global Clean Energy Ishares ETF
-0.61%13.02
ZGI-T
BMO Global Infrastructure Index ETF
+1.35%41.89
RSPH-A
S&P 500 EW Health Care Invesco ETF
+0.44%29.43

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