The rapid rise of thematic investing has caught the attention of European ETF providers as growing demand from clients, the changing investment landscape and the saturated core market offer them an alternative opportunity to capture major flows.
Thematic investing looks to identify the market leaders and trends of the future which are at the forefront of technological revolution. It is the latest fad to attract interest from the investment community with themes ranging from cloud computing, electric vehicles or battery storage.
In the past year, ETF providers, in particular, have identified an opportunity to capture the increasing interest from clients. Last year, thematic ETFs listed in Europe quadrupled from four to 16, according to Morningstar, while annual inflows has jumped from ¬£158m in 2014 to ¬£1.8bn in 2018.
Competition to capture these themes is increasing. In February, First Trust Global Portfolios (FTGP) launched a cloud computing ETF (FSKY) with a total expense ratio (TER) of 0.70%, undercutting HANetf and GinsGlobal Index Funds' cloud technology ETF (SKYY), which launched last October, by 5 basis points.
Meanwhile, in the artificial intelligence (AI) space, WisdomTree, DWS and Amundi listed ETFs within the last year with TERs of 0.40%, 0.35% and 0.35%, respectively.
Along with the boom in launches, performance has been strong. According to Bloomberg, the top performing US-listed funds so far this year are three thematic ETFs; the ETFMG Alternative Harvest ETF (MJ), the Invesco Solar ETF (TAN) and the Invesco Wilderhill Clean Energy ETF (PBW), as at the end of February.
A key aspect of thematic investing is its ability to tap into powerful narratives that are easy for the end investor to understand.
Instead of talking about the shape of the yield curve or factor investing, financial advisers can easily communicate to their clients why artificial intelligence, for example, can be a long term satellite holding in their portfolio.
As Kenneth Lamont, ETF research analyst at Morningstar, says: "In a world littered with jargon and abstract financial theory, thematic investing represents a pleasingly straightforward approach to investing."
While, Simon Klein, head of passive sales for Europe and Asia Pacific at DWS, adds: "On the retail and advisory part of the market, thematic ETFs are the perfect product to tell a story about the future."
Furthermore, another driver is around access. Prior to thematic ETFs, Howie Li, head of ETFs at Legal & General Investment Management, explained once investors had identified a certain theme such as blockchain or ecommerce it was difficult for them to capture it in any investment vehicle.
"Without thematic ETFs, it would be much a more challenging process for investors to gain exposure or express a view on these new industries," he said.
His views were echoed by Hector McNeil, co-CEO of HANetf, who said the changing world and changing investor preferences meant asset managers had to re-think their strategies in terms of capturing flows.
With investing becoming more personal than ever before, McNeil continued, investors had started to request solutions that reflect their interests, values and ideals.
"Without thematic ETFs, it would be much a more challenging process for investors to gain exposure or express a view on these new industries. Asset managers that want to position themselves for future growth are looking to wrap their investment ideas as ETFs.
"Because ETFs are a convenient portfolio building block, investors can incorporate ESG, cloud computing or any number of other trends into a bespoke portfolio," McNeil added.
As technological change is behind the majority of these themes, it is important for investors to look under the bonnet of the ETF they invest in.
There is a risk investors can end up becoming too exposed to regular technology stocks such as the FAANGs, which may already be a major part of their core holdings.
Li said one example where this can occur is in cloud computing as the universe is simply not large enough and investors can end-up with a portfolio of the "usual suspects" such as Amazon: "What you want from thematic investing is to diversify your portfolio, get access to companies you do not already have access to and to capture the theme through unique exposures."