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Behind the numbers: Thematic ETFs on the rise and fees staying high

A closer look into the increase in popularity of exchange-traded funds capitalising on long-term trends

Artificial intelligence, cloud computing and battery value chain are just some of the attention-grabbing themes tracked by exchange-traded funds launched this year. These new entrants join established thematic funds such as robotics and water strategies. Assets in these ETFs have skyrocketed over the past three years, increasing sevenfold, albeit from a low base. Total European assets now sit at £5.6bn, according to Morningstar data.

What are thematic ETFs?
Designed to capitalise on long-term trends, these ETFs at times resemble sector funds, but remain distinct.

Thematic ETFs can be defined as those that select holdings based on their exposure to a specific investment theme.

They attempt to profit from long-term macro or structural trends such as environmental changes, demographic shifts or technological advances. The grouping includes funds like ageing population or robotics ETFs, but excludes those like Japanese exporters ETFs, which are useful for making economic calls but lack a cohesive longer-term narrative that transcends the business cycle.

What is on offer?
We have identified 31 ETFs in Europe that meet our definition of thematic. Within that list are a jumble of themes and approaches.

To have a better understanding of what is on offer, we have grouped these ETFs loosely into three buckets: technology, environmental and social.

Hogging almost three quarters of total assets, technology thematic ETFs are the most popular grouping, as seen in chart 1. The biggest winners have been the robotics and automation strategies. Also available are several ETFs focusing on the digitisation of the global economy or health/pharma tech.

Environmental themes tie together the second most popular grouping. These funds tend to be older than their tech counterparts.

They are dominated by natural resource ETFs, in particular those with a water focus, which are designed to gain from shortages in fresh drinking water, exacerbated by a changing climate and a booming global population. Finally, a handful of funds that have launched in the past few years focus on social themes, such as an ageing population and gender diversity.

Chart 2 shows that not only are thematic ETFs, with an average ongoing charge of 0.59 per cent, much more expensive than the average equity ETF (0.38 per cent), but they are also pricier than sector (0.35 per cent) and strategic-beta (0.37 per cent) ETFs. The asset-weighted average fees across each cohort tell a similar story, with thematic ETFs levying an ongoing charge of 0.53 per cent, versus 0.39 per cent, 0.37 per cent and 0.27 per cent for sector, strategic-beta and all equity ETFs, respectively.

While there is undoubtedly a cost to researching and sourcing relevant data for a given theme, a lack of assets and the competitive forces they bring with them have caused fees to remain elevated.

However, we can be sure that the recent success of certain thematic funds will attract new players to the market, likely applying downward pressure on fees. Ongoing charges have already begun to fall, with eight of the 10 cheapest thematic ETFs having been launched since August 2016.

How have they performed?
Assessing performance can be tricky for newer funds. More than half of all surviving thematic ETFs were launched in 2017 or 2018, meaning that they lack a sufficient live track record. That said, we can assess the performance of older offerings.

Chart 3 looks at the three-, five-, and 10-year annualised returns of five thematic ETFs relative to their surviving category peers.

It shows that these funds have outperformed their average peers over most timeframes. Fee differentials between ETFs and their active peers have been a key ingredient in their success.

However, compared with the performance of the same group of funds against the MSCI World index over the same period, they have struggled to outperform and, in some cases, underperformed the benchmark by a wide margin.

Passing fad or enduring theme?
Thematic funds rightly have to fend off accusations of being gimmicky, or of tapping into fashions that will soon swing out of favour as interests shift to the next big thing.

We need only glance at the rogue wave of launches and subsequent closures of internet-themed funds in the late 1990s and early 2000s to validate this concern.

The high mortality rate of thematic ETFs specifically is also noteworthy. Almost 80 per cent of thematic ETFs launched in Europe prior to 2012 have since closed. Caution is therefore warranted.

As usual, a sceptical approach will yield the best investment outcomes. While fund providers will give you plenty of reasons you should invest, it pays to examine their claims closely.

Kenneth Lamont is an analyst in passive strategies at Morningstar



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