A generation ago, financial planners were expected to provide a steady stream of smart stock picks for our clients. In fact, a request for a hot stock tip was often the first question we were asked at dinner parties.
But times have changed, and most clients have come to see that a balanced portfolio of funds is the savvier approach. In short, advisors have gone from stock pickers to fund pickers.
And it’s a change for the better because it’s difficult to build portfolios that are perfectly matched to a client’s risk tolerance, liquidity needs and long-term time horizons when it’s based on individual stocks.
Still, there are some clients who think of themselves as stock jockeys at heart. They get deflated when told that individual stock selection is not the best path to wealth creation and capital preservation.
For these clients, there is a nice compromise at hand: thematic ETFs. These funds zero in on some of the most dynamic industry trends in the global economy. To be clear, they’ll never be as cheap as the large market-tracking index funds. And they should never account for the bulk of any retirement portfolio; instead, they offer smart tactical exposure that potentially can add alpha to a portfolio.
“They started popping up in the past 10 years, and more recently have really captured lightning in a bottle in terms of performance and asset gathering,” says Todd Rosenbluth, director of ETF and mutual fund research at CFRA.
Zooming In On Tech
Many thematic ETFs target the major tech trends expected to play out over the coming decade and/or trends that are already in place. Cybersecurity, for example, accounts for a growing portion of IT budgets as firms look to beef up their networks to keep out intruders. The ETFMG Prime Cyber Security ETF (HACK), with $1.62 billion in assets and a 0.60 percent expense ratio, can help clients avoid the risk of owning a lagging stock in the group by providing a portfolio approach to the spending trend. In tandem with rising cyber defense budgets, this fund is on pace for its fourth straight profitable year and has gained 21 percent on average over the past three years.
ETFMG offers other cutting-edge thematic ETFs in areas such as drones and mobile payments.
Elsewhere, sectors such as robotics, artificial intelligence and automation have been popular with investors. Take the Robo Global Robotics & Automation Index ETF (ROBO), which launched in October 2013, has nearly $1.5 billion in assets and charges at stiff 0.95 percent expense ratio.
It’s important to let clients know that funds like this can be very volatile. ROBO’s share price more than doubled over the course of 2016 and 2017, plunged more than 20 percent in 2018, and has rebounded 19 percent in 2019.
Rosenbluth says hot thematic ETFs that have gathered sizable asset levels tend to invite competition, and the newer funds tend to lure assets away on price. The Global X Robotics & Artificial Intelligence ETF (BOTZ), for example, has a more modest 0.68 percent expense ratio, which has helped it to amass $1.75 billion in assets even though it launched three years after the ROBO ETF.
Rosenbluth cautions that seemingly similar funds can own very distinct portfolios and deliver divergent returns. “It’s important to look at the weightings and definitions when comparing funds like these,” he says.
The BOTZ fund has large and concentrated weightings in factory floor automation firms such as Fanuc, Mitsubishi Electric and ABB. The ROBO fund, in contrast, more evenly weights its constituents and no holding accounts for more than 2 percent of the fund. It also has a greater emphasis on chipmakers and chip equipment suppliers. Rosenbluth suggests that thematic funds are well-built for longer-term returns “but in the short-term will be very bumpy.”
Go Big Or Go Home
Smaller thematic ETFs that fail to attract enough assets sometimes are shuttered due to a lack of traction. In fact, more than a quarter of thematic funds launched before 2012 have already closed, according to Morningstar. And some of today’s smaller ones may eventually be culled as well.
A good rule of thumb is to focus on ETFs with at least $100 million in assets and at least 100,000 shares in daily trading volume. That curtails the risk of owning a fund that could be headed for the chopping block.
I’ve had clients ask if they should buy cannabis stocks, and I give that suggestion a thumbs down because many of these firms have weak balance sheets and unproven business models. Instead, I tell them about the ETFMG Alternative Harvest ETF (MJ), which has more than $1 billion in assets and spreads its bets across roughy 30 cannabis-related firms (the fund also includes eight tobacco companies). They may wince at the 0.75 percent expense ratio, but they like that their investment can’t be sunk by just one bad stock pick.