*This article is produced in partnership with J.P. Morgan Asset Management Australia

Thematic ETFs are in vogue

Thematic exchange-traded funds (ETFs) have become popular in recent years1. The demand is partly due to the rapidly increasing interest in key themes such as disruptive technology, healthcare, demographic changes, urbanisation and environment, social and governance (ESG) investing.

As such, thematic ETFs are focused on asset classes that are positioned to make the most of these megatrends and themes2. Additionally, ETFs are transparent and present exposure to liquid and tradeable holdings without the pressure of picking each single winning holding and market-timing, as well as access to assets such as listed infrastructure.

Globally, there were 202 new launches in the first nine months of 20223, compared with 300 for the whole of 2021, according to Trackinsight’s Global ETF Survey 2022. Thematic ETFs account for over US$215 billion ($320 billion) in assets under management as of end-3Q 20223.

Becoming increasingly active…

Much of the demand for thematic ETFs has been met by passive strategies, which track benchmarks that are specially constructed to give a broad exposure to a particular theme1. The indices are compiled using rules-based stock selection that aims to create an economic linkage to the selected theme.

Thematic equity indices tend to focus on what are often referred to as pure-play stocks – companies whose activities lie within the scope of a particular theme. For example, in a clean energy index, only companies heavily involved in the generation of renewable energy may be included. They may exclude companies that play a role in energy transition, such as those enabling electrification, including electric-vehicle charging.

Thematic equity indices are also often weighted by market cap, or by a simple equal-weighting construction. The growing number of thematic ETFs and the relatively small number of pure-play stocks can result in many funds chasing the same stocks and investing in highly crowded positions.

As such, active strategies are becoming increasingly popular as investors recognise their greater flexibility and the added value they can deliver over and above passive strategies.

…and more flexible

An active approach has much more embedded flexibility in the construction of the ETF portfolio1,2. Active thematic ETFs often have a much broader investment universe, such as the MSCI All Country World Index, which can give access to the full opportunity set of a theme.

Additionally, active portfolio managers can implement investment ideas without being limited to the stock selection and rebalancing rhythms set by index providers. Passive ETFs usually rebalance only every three months and so cannot adapt to changing market conditions as quickly.

Another advantage to active thematic managers is their ability to take a much more granular approach to portfolio construction and give more weight to companies they believe can provide the most impactful and effective exposure to the selected theme, from across the market rather than limited to certain sectors or types of stock.