Since their humble beginnings back in the early 1990s, exchange-traded funds have seen an extraordinary level of growth both in assets under management and in the number of ETFs available.
What started life as a simple investment product designed to track the performance of a plain, 'vanilla' index such as the FTSE 100 or S&P 500, has now ballooned into more than 7,000 products, covering a wide range of options and flavours.
There are ETFs that cover specific geographies or regions, ETFs that track individual sectors such as oil and gas, smart beta ETFs that invest in certain factors like value or growth, leveraged ETFs that offer two or three times the return of certain stocks (long or short) and more recently, thematic ETFs.
While some of these newer ETF styles are more ‘exotic’ than others, thematic ETFs, on the face of it, are relatively simple.
They are based on the principle of thematic investing; an approach that seeks to identify long-term structural trends that can drive growth in a rapidly changing world. As a result, many thematic ETFs are centred on mega-trends.
BlackRock and MSCI have identified a number of mega-trends that threaten to disrupt the economic and social landscape of the world, giving birth to new industries and technologies, as well as destroying old ones.
These mega-trends range from technological breakthroughs in automation, robotics and artificial intelligence, to climate change, renewable energy and more.
Thematic ETFs simply allow investors to hone in on the changing dynamics that these mega-trends could bring over the next five to 10 years by investing in specific industries rather than just sectors, factors or geographies.
How do thematic ETFs fit into a portfolio?
Innovation is happening all around us and as investors we do not want to miss out on future growth.
Investing in traditional market cap-weighted indices such as the S&P 500 or MSCI World may be too broad to express certain convictions. Investing in individual stocks is difficult enough as it is, let alone trying to identify ones that will be best placed to take advantage of shifting dynamics.
This is why thematic ETFs can be a great way to express convictions without having to rely on successful stock picking or finding active managers that are capable of delivering consistent success.
One advantage of a passively managed thematic ETF is the automatic rebalancing that takes place. Yes, the ETF will buy winners and losers, but overtime, the winners get bigger and losers get smaller.
While it will not be possible to make the stellar returns potentially on offer from the select group of companies that morph into the Amazons and Googles of the future, it is important to remember what happened during previous mega-trends.
A classic example of a mega-trend and why investing passively may be better going forward is the advent of the motorcar in the early 20th century.