If the market for so-called “smart beta” exchange traded funds (ETFs) is, by now, close to saturated, what is the next wave coming out of asset management shops? By the flood of recent launches, it looks like thematic ETFs, which, along with factor-based funds, comprised half of all ETF launches so far this year. They include funds built to capture the performance of companies addressing themes like the obesity epidemic, the millennial generation and the changing market for agriculture and food production.
Is there room for yet more ETFs based on ever narrower, and ever more creative, slices of the market? “If you’re someone who is happy with an environment, social and governance fund or a cybersecurity fund, that’s a good fit,” says Eric Balchunas, an ETF analyst with Bloomberg Intelligence. But you have to know what stocks the fund holds—this should not be approached like blind indexing. If there’s a lot of overlap with what you already own in other funds, it probably doesn’t make sense, he says. In addition, many of the funds have small- and mid-cap stocks, which makes their price movement more volatile.
Ben Johnson, director of ETF research for Morningstar, has a more direct take. “The ETF industry has dusted off the spaghetti bazooka and said, ‘ready, fire, aim,’ to see what it can get to stick to the wall.” The usefulness of new ETFs has diminished markedly over the last few years, Johnson says. The funds’ themes are essentially based on news headlines, and their fees are steep, he maintains.
Global X launched the Millennials Thematic ETF in May. The fund tries to take advantage of the fact that millennials—those born between about 1981 and 1997—are the largest generation in U.S. history, numbering 75 million and earning about $2 trillion a year. They’re also set to inherit $42 trillion, says Jay Jacobs, director of research for Global X. The fund has 73 holdings seen as benefiting from increased spending by millennials.
Millennials Thematic focuses on eight industries: social and entertainment; clothing and apparel; travel and mobility; food, restaurants and consumer staples; financial services and investments; housing and home goods; education and employment; and health and fitness. The ETF’s five biggest holdings are LinkedIn Corp. (4.9 percent), Amazon.com Inc. (3.5 percent), Fiserv Inc. (3.2 percent), Facebook Inc. (3.1 percent) and Intuit Inc. (3.1 percent).
Institutional investors have used thematic investing for some time, and thematic ETFs like this one allow average Joes in on the action, Jacobs says. “This is a democratization. It’s difficult for advisors and individual investors to do bottom-up research.”
But Balchunas isn’t sold on the Global X fund. It consists largely of Internet and shopping names, he notes. “You can get that through a plain vanilla fund.” The millennial ETF has an expense ratio of 0.68 percent, compared to 0.09 percent for the SPDR S&P 500 ETF. “Fees for thematic ETFs tend to be many multiples of broad stock market exposure,” Johnson says. But the median expense ratio for passive ETFs as a whole is 0.49 percent, according to Morningstar.
When it comes to returns, Jacobs says Global X’s expectation is that its funds will outperform the broader stock market, justifying their lofty fees. “This is primarily a growth play,” he says.
Nick Cherney, head of exchange traded products at Janus Capital Group, which just began four thematic ETFs with expense ratios of 0.5 percent, was more cautious. The aim of its funds is to improve investors’ risk-adjusted returns, he says. “The purpose is to increase exposure to long-term trends.”
But given the fact that most thematic ETFs have entered the scene during the past few years, there is little long-term performance data. “Many that were launched have now been shuttered,” Johnson says.
Janus’ new funds include:
- The Long-Term Care ETF, which seeks to benefit from the increasing elderly population. It invests in companies owning or operating senior living facilities, nursing services, specialty hospitals and senior housing; biotech companies for age-related illnesses; and companies that sell products and services to such facilities. The top three holdings are real estate investment trusts (REITs) Ventas Inc., Welltower Inc. and Senior Housing Properties Trust.
- The Health and Fitness ETF, a play on the increase of spending for physical activity. It invests in companies involved with fitness technology/equipment, sports apparel, nutrition and sports/fitness facilities. The top three holdings are Nike Inc., Lululemon Athletica Inc. and Adidas AG.
- The Organics ETF, designed to profit from the growth of that industry. It invests in companies that service, produce, distribute, market or sell organic food, beverage, cosmetics, supplements or packaging. The top three holdings are Whole Foods Market Inc., United Natural Foods Inc. and Hain Celestial Group Inc., which sells food and personal care products.
- The Obesity ETF, which is based on the rise of that disease and efforts to treat it. It invests in biotechnology, pharmaceutical, health care and medical device companies focusing on obesity and obesity-related disease. The top three holdings are Fresenius Medical Care AG, a German medical supply company; Novo Nordisk A/S, a Danish pharmaceutical company; and Dexcom Inc., which makes glucose monitoring systems for diabetes management.
Janus used three screens in creating these funds. “First it had to be a theme where it would instantly be agreed by everyone that the theme would persist for multiple years,” Cherney says. “Second, it had to be something that was narrowly definable and investable.” And finally, the funds need to be “commercially viable.”
The first hurdle can be a steep one, says Todd Rosenbluth, director of ETF research for S&P Global Market Intelligence. “Many products are tied to whether the theme resonates in the current environment,” he says. “The challenge is that the environment is constantly shifting.” In any case, the funds will succeed or fail based on their individual holdings. “If you are going to be in these funds, you need to be sure it complements your portfolio,” Rosenbluth says.
But Johnson says many of the new thematic ETFs are simply based on trends popularized in the media, though he didn’t cite any specific funds. “It’s a land grab” by ETF companies, he says. Their attitude is “we’re going to line up a dozen themes to see if we get the timing and sales strategy right to get some money.”
Balchunas isn’t quite so skeptical. “These give you a chance to outperform the market, and certain investors want that,” he says. But even he estimates only about 5 percent of thematic ETFs will successfully add value to investors’ portfolios.
Dan Weil is a freelance financial writer. His work has appeared in The New York Times, The Wall Street Journal, Bloomberg, Institutional Investor, Bankrate.com, Slate magazine, Newsweek.com and Tennis magazine. He has also worked as a reporter at Bloomberg, Reuters and Dow Jones.