What advisers need to know about thematic ETFs

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.

This amazing new technology, driven by the internal combustion engine, spawned thousands upon thousands of different car manufacturers all over the world. However, the number of car manufacturers that survived and turned out to be viable over the longer term can almost be counted on one hand.

This example represents the biggest problem for investing in mega-trends; you believe the new technology or industry will grow and fundamentally change the way we do things, but how do you gain access to this growth when there are usually more losers than winners over the long term or, at least, very few big winners. Investing in a thematic ETF can potentially solve this issue to an extent.

While thematic ETFs can be a great way to gain low-cost diversified exposure to different themes, they are not immune to bubbles, such as the dotcom excitement we witnessed in the late 1990s and early 2000s.

The hype around the internet (a mega-trend) led to excessive speculation of internet-related companies purely on the basis of their name or the sector/industry they were in.

Investors become obsessed with certain types of company rather than the fundamentals and whether the company made a profit. In many instances, investors did not even know what the companies they were buying did.

This is something to watch out for in thematic ETFs, in case the hype around the theme does not play out as expected.

What thematic ETFs are currently available?

iShares have a suite of thematic ETFs that offer access to five different mega-trends they have identified.

The most popular of these is the iShares Global Clean Energy ETF, which invests in companies involved in the provision and production of clean energy equipment and energy itself.

While thematic ETFs can give your portfolio an edge, knowing which mega-trend to target is the hardest part and something that investors have been trying to do since time began

When looking under the bonnet of the ETF, it only holds approximately 75 companies and the top 10 holdings account for just over 50 per cent of the fund. This highlights the higher levels of concentration these ETFs can have over more traditional ETFs.

Wisdom Tree is another ETF provider that offers a range of thematic ETFs. Its range offers products that track one of their six identified mega-trends.