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Active interest in thematic ETFs

Active interest in thematic ETFs

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7 minute read

Market conditions have tested the appeal of thematic ETFs, but their ability to deliver diversification, megatrend exposure and outcomes for investors remains intact, writes Brett Grant, head of product and trading at AUSIEX.

Exchange-traded funds (ETFs) have been one of the remarkable success stories of the Australian sharemarket. From when they were first listed in late 2015, they now have a market capitalisation of $120 billion on the ASX, providing investors with an ever-growing range of investment strategies.

There are many reasons why ETF managers have been able to roll out a steady stream of new products and why investors continue to support these funds. Their variety, low cost, and ability to provide investors with exposures to multiple stocks in a single trade have attracted a growing legion of fans.

AUSIEX’s 2021 Trading Transformation report showed that ETFs were increasingly being favoured by advisers for ease of implementation and price.

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ETF take-up by advisers trading through platforms more than doubled during COVID-19 as accounts went from an average of one in five trading an ETF pre-COVID to over half during COVID-19, and two in three by the start of 2021.

But the convenience and variety of funds do not mean advisers or investors should see them as “set and forget” means to play the market. With the market shake-out during the June quarter, it has been a valuable time for investors to review their holdings.

One sector to keep a closer eye on in particular is the performance of so-called “thematic ETFs”, which have grown rapidly in number and size over recent years but have yet to be tested through a full-market cycle.

Thematic ETF funds focus on sectors experiencing transformational macroeconomic, technological, and environmental trends that are reshaping businesses, or society more generally. As a result, they are seen to have the capability to enhance portfolio outcomes over time.

These types of ETFs have been particularly compelling for young and new investors, providing them with a quick way to back big themes that are important to their investment strategy.

AUSIEX data suggests they are also of interest to older and more established investors to gain satellite exposure to supplement core holdings, or to tilt a portfolio towards a particular theme, such as renewable energy or data security.

Adviser use of ETFs

Some advisers have also used thematic ETFs as a way of diversifying their clients’ portfolios and gaining greater exposure to global markets. Notwithstanding the interest in this market, these ETFs have been caught up in the general financial market sell-off over the past six months as investors have reviewed and reshaped their portfolios.

After all, rising inflation and interest rates, Russia’s invasion of Ukraine, a collapse in tech stock valuations and soaring prices for oil and commodities were not really on the horizon at the end of last year. Australian interest rates only began rising in May and now are set on a path to the most aggressive tightening cycle ever seen in Australia.

This transformation in the traditional macroeconomic factors that had been driving equity markets higher arguably helped spur investors to switch to more thematic plays, but that trend may have slowed.

Thematic trends

As we have examined on our content site, AXIS, the thematic ETFs that fuelled much of the broader ETP markets growth in recent years are under scrutiny. With tickers such as FOOD, ACDC, ROBO, HACK, DRIV, ERTH, CRYP, FANG, and DRUG, these thematic funds account for around 20 per cent of the 252 ETFs listed on the ASX.

At AUSIEX, we have seen investors shift away from some of these themes over the past six months, in keeping with the broad market sell-off and towards yield investments that are expected to do better at a time of supply-side inflationary pressures and rapidly changing interest rates.

AUSIEX ranking data has shown trading volumes have fallen away for some of the major thematic ETFs relative to all other ETFs recently, with:

  • ACDC (battery technology and lithium) sliding to 20th (of all ETFs traded) in June 2022 from 13th in March 2022;
  • HACK (cyber security) down to 22nd from 12th in January 2022;
  • CRYP (crypto economy) down from first position in November 2021 to 30th in July 2022; and
  • CLNE (clean energy) falling from 51st in January 2021 to 98th in June 2022.
Meanwhile, as rates have been rising and sharemarkets have been falling, quality shares have been a theme on the rise as they tend to offer investors relative protection during weaker economic environments and heightened market volatility. VanEck’s MSCI International Quality ETF — the second most actively traded ETF at the end of July 2022 — have been as low as ninth in June 2021.

And as the drums beat more loudly, signalling that we may be heading for a global recession, thematic ETFs focused on climate change and the industries that are expected to prosper from global moves to address it appear to have kept investor interest, which has helped flows into some of them.

For example, as mentioned above, the ETFS Battery and Lithium ETF (ASX: ACDC), which allows investors to tap into companies in the fast-growing renewable energy and storage industries, was down 20 per cent in early March as the tech stock sell-off peaked but seemed to have regained favour with investors.

Environmental, social and governance factors (ESG) are increasingly at the forefront of the minds of ETF investors as they make their investment decisions.

Recent research shows the focus of investors globally on climate change has accelerated over the past year, with 86 per cent of institutional and wholesale investors expecting climate change to be at the centre of their investment policy, or a significant factor in it, in the next two years. That compares to 73 per cent that say climate change is already a significant factor, up dramatically from 33 per cent two years ago.

There has also been a heightened policy focus on climate since the change of government in May and a growing recognition of the scale and length of effort that will be required to address it.

In the seats that moved from the Coalition to the climate-focused Teal independents at the election in May, there was a much higher level of trading in stocks and funds addressing climate change relative to other electorates. Our analysis found there were 200 per cent more investors trading ESG-related securities and 151 per cent more trades placed, which were worth 188 per cent more in value when compared to other electoral divisions.

Both genders have also embraced ESG stocks, with female traders trading a little more in the sector during the COVID lockdown period. The gap was widest among Generation Z and Millennial traders, with younger generations more likely to invest according to their values.

Going global

Australian investors do not have many local options for playing this and other megatrends on the local sharemarket, so overseas stock-laden ETFs seem to have become a preferred option.

Around 10 per cent of our active traders continue to invest in thematic ETFs, with the buy-to-sell ratio at 3:1.

Among the more heavily traded thematics on AUSIEX in recent weeks have been the Vanguard Australian Shares High Yield ETF (ASX: VHY), the Vanguard Diversified High Growth Index ETF (ASX: VDHG) and the ETFS Semiconductor ETF (ASX: SEMI).

If fears of a global recession become a reality, investors may choose to remain on the sidelines until there are signs of recovery.

However, even after difficult market conditions, financial advisers and their clients continue to see ETFs and thematics for their part as efficient and effective ways to provide diversification for clients and to target certain outcomes, be that yield, climate change or franking credits.

Active interest in thematic ETFs

Market conditions have tested the appeal of thematic ETFs, but their ability to deliver diversification, megatrend exposure and outcomes for investors remains intact, writes Brett Grant, head of product and trading at AUSIEX.

Active interest in thematic ETFs
Active interest in thematic ETFs
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Maja Garaca Djurdjevic

Maja Garaca Djurdjevic

Maja's career in journalism spans well over a decade across finance, business and politics. Now an experienced editor and reporter across all elements of the financial services sector, prior to joining Momentum Media, Maja reported for several established news outlets in Southeast Europe, scrutinising key processes in post-conflict societies.

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