"The trend is your friend." This tongue-in-cheek adage often used to describe momentum investing is not usually paired with the surgical precision of exchange-traded fund investing, but maybe it should be.
Megatrend and thematic ETFs have taken hold in the retail market and are gaining attention from large financial intermediaries, family offices and other mission-driven investors. To some, megatrend vs. theme is a distinction without a difference, but Chad Slawner, head of U.S. iShares product and strategy for BlackRock Inc., says otherwise.
"Themes tend to be cyclical, whereas megatrends are structural," said Mr. Slawner.
Through July 24, U.S.-listed thematic equity ETFs had $48.9 billion in assets under management, according to Bloomberg Intelligence data. Through June, collectively, these 109 funds saw net flows of $2.3 billion on top of $8.5 billion in 2018, while 13 funds hold more than $1 billion in assets and another nine hold more than $500 million.
The success of one of the earliest thematic ETFs — the $9.1 billion First Trust Dow Jones Internet Index Fund, launched in 2006 — set the stage for the recent land grab of ETFs trying to capture the zeitgeist of emerging trends. While funds focused on developments in cannabis, blockchain and politics are fodder for headlines, several issuers are looking for more expansive trend-based offerings to take hold.
"Conviction — is this going to be a disruptive global trend and not just a 'moon shot' — is critical," said Jay Jacobs, head of research and strategy at Global X Management Co. LLC, a unit of Mirae Asset Global Investments, which currently offers 14 thematic equity ETFs.
Traditionally the province of high-conviction active managers, megatrend-based ETF investing requires either a fully transparent active model, as practiced by ARK Investment Management (Pensions & Investments, July 8), or a highly quantitative research process to test themes and build global cross-sector indexes.
"About 40% of the themes that our product development team researches never make it to a final index," said Rahul Sen Sharma, managing partner at Indxx LLC in New York. "Most of the time the theme may in fact be too early in the cycle, and there aren't enough names to build a liquid, investable index, or that the theme isn't long-term enough for us to feel confident that it will be around in 10 years."
According to Mr. Sharma, more than $5 billion tracks Indxx indexes in more than 60 products around the world. In the U.S., the company provides the index for the $1.5 billion Global X Robotics and Artificial Intelligence Thematic ETF and the $517 million Global X Cloud Computing ETF, as well as 24 other products built on technological, scientific and demographic trends.
For the largest ETF issuers, trend-based equity ETFs looked like an afterthought until recently, with more focus on covering the waterfront of market-cap weighting, conventional industries, sectors and geographies as well as "smart beta" and factor investing. But the success (and higher fees) of products based on more targeted indexes has ETF giants BlackRock and State Street Global Advisors wading deeper into trends.
SSGA, for example, sponsors six "new economy" ETFs based on indexes built by Kensho Techologies LLC, an S&P Global company that track mobility, clean power, security, intelligent structures and space exploration, as well as a composite.
BlackRock is building out its focus on the megatrends of technological breakthroughs, demographic and social change, rapid urbanization, climate change and resource scarcity, and emerging global wealth. The cornerstones of BlackRock's strategy are the $2.6 billion iShares Exponential Technology ETF, launched four years ago to track an index from Morningstar Inc. that includes 200 constituents across sectors and geographies, and the $3.2 billion iShares Global Infrastructure ETF, launched in 2007 on an index from Standard & Poor's.
"These products attract investors with high conviction around certain trends," said BlackRock's Mr. Slawner. "Yet they remove the idiosyncratic risk of single stock selection and capture multiple pieces of the value chain."
But as with any index (or active) ETF, similarly named funds can vary widely in performance and exposure. For example, the recently launched Global X Cloud Computing ETF has very little overlap with the $2.3 billion First Trust ISE Cloud Computing ETF.
Some thematics use an equal weighting strategy, such as the $186 million Invesco Cleantech ETF.
Perhaps the greatest challenge when discussing thematic and megatrend ETFs with institutional investors is that the products "are by design not benchmark-aware," said Global X's Mr. Jacobs. "One of the appealing aspects (is) an opportunity for uncorrelated growth and exposures that are very different to their core portfolios."n
