Exchange-traded funds (ETFs) are one of the most popular ways to passively invest in the stock markets today. They are traded just like an equity, with their price fluctuating by the minute, and you can buy or sell them at any time during an active trading session.
One of the main reasons retail traders like the idea of ETFs is their bundled nature. They combine a basket of assets into one tradeable product, giving you exposure to multiple companies with a single trade. In recent years, ETFs have evolved from focusing solely on replicating the performance of popular indices like the S&P 500, the Dow Jones, and the FTSE 100. In fact, there’s been a significant spike in the number of thematic ETFs doing the rounds.
What is a Thematic ETF?
While some retail traders like the idea of broad-based exposure to the financial markets, others prefer to home in on niches they know best. Thematic ETFs are, therefore, a strong option for investors keen to specialise in the equities they buy for the long term. You can now find baskets of sector-specific ETFs, as well as themed ETFs focused on societal shifts like stocks, which put environmental, social, and corporate governance (ESG) at the heart of their operations.
The Benefits of Trading Thematic ETFs
- Thematic ETFs allow you to tap into the latest trends in the global economy. These baskets of assets give you immediate access to the equities representing these trends with a single click.
- One of the main benefits of thematic ETFs is that they’re just as tradeable as other contract for difference (CFD) products like indices and forex. Most online trading brokerages will offer themed ETFs hand-picked by world-leading asset managers, including BlackRock. This gives retail traders the reassurance they need to trade baskets of assets that have been researched by time-honoured professionals.
- If you’re passionate about a certain trend or sector, you can invest in a thematic ETF focused on it. You can pick the fund with the companies you think have the best long-term potential in this trend.
The Drawbacks of Trading Thematic ETFs
- One of the keys to sustainable, long-term investing is diversifying your risk across a broad basket of sectors. Thematic ETFs can encourage retail traders to invest in narrow fields, some of which may be very new to the financial markets, too.
- In many instances, the ongoing annual management charges for thematic ETFs are considerably higher than broad-based ETFs, which cover the entire US or global market. These magnified management fees can eat into your returns over 20-30 years.
- As many thematic ETFs are relatively new on the scene, there is often a great deal of price volatility. That’s because the liquidity of these ETFs is yet to heat up. This means the spreads between the buy and sell prices are usually much greater than when you buy into well-established ETFs.
- Not only do thematic ETFs narrow your diversification in the financial markets, but they also typically underperform the wider market. If you’re investing long-term, you could be much better off spreading your risk in an all-world/global ETF tracking equities in developed and emerging markets.
Ultimately, thematic ETFs have veered away from the very principle of investing in index funds, which was to achieve broad exposure to an entire asset class. The fear is that these so-called trendy themes or sectors will run out of steam in the short to medium term when another fad enters the market.
The lack of historical performance will also make some retail investors uneasy when gauging expected returns from a thematic ETF. In summary, they are an option to introduce into your portfolio mix, but only if you have a deep understanding of the theme and its long-term prospects.
