Index funds have become serious business in recent months, surpassing the value of stock pickers for the first time in August 2019 and accumulating $4.27tn in assets in the US, according to data from Morningstar.
At the forefront of this growth is the steady incline of ETFs – a collection of securities that trade on an exchange like a stock – which have been steadily gaining popularity since their conception 27 years ago. Even more recently, it’s a particular kind of ETF that is grabbing headlines.
Thematic ETFs are on the rise and look set to make the biggest changes in 2020 and beyond. Unlike their traditional counterpart, these funds focus on identifying disruptive macro-level trends.
Valuation of assets in the US accumulated by index funds in August 2019
These thematic ETFs are often unconstrained by more traditional sector and size groupings. They seek to capitalise on emerging (and often lucrative) trends that stretch across borders and conventional business segments, which can be appealing for many investors.
A look at the figures
Globally, thematic investing has tripled over the past five years to around $40.76bn, Morningstar figures show. In Europe specifically, the size of the thematic ETF market has more than doubled in the past two years, according to Money Marketing.
In the US, there are currently 121 thematic ETFs that have produced $27.8bn in assets under management in aggregate. These funds saw $326.7m in net inflows and assets grew by $2.7bn (11%) during Q4 2019.
Valuation of assets under management produced by 121 thematic ETFs in the US
While Global X – an ETF provider that started tracking thematic ETFs last year – stated in its recent report that thematic ETFs represented only 0.6% of the $4.4trn in assets in the US ETF industry, it also highlighted this is a fast-growing space in the industry.
Simplicity is key
According to consultancy Deloitte’s 2020 investment management outlook products focusing on “megatrends” will be a key focus in the near future. “These thematic approaches may draw a stronger connection with investors in 2020 than some previous classification systems, such as large-cap value, which are devoid of emotional connection,” the company stated.
JP Morgan’s 2019 Global ETF report shows that investors have a three-pronged reason for preferring thematic ETFs: they are attracted by niche market exposure, the simplicity of concept and the return from long-term structural trends.
“These thematic approaches may draw a stronger connection with investors in 2020 than some previous classification systems, such as large-cap value, which are devoid of emotional connection” - statement by Deloitte
The report also found that investors who do not currently use ETFs were more attracted by the simplicity and potential returns of thematic funds than their traditional counterparts.
The pull of a simple concept cannot be underestimated. Sarah Newcomb, behavioural economist at Morningstar, has previously explained that the appeal of a simple narrative is incredibly powerful, as it’s easy to remember and easy to digest. This chimes with Deloitte’s view that megatrends are drawing the interest of investors because of some “emotional connection”.
The 2020 themes
Furthermore, many of the new trend-focused funds that are emerging in 2020 are incredibly evocative. Zacks Equity Research points to a number of popular ETFs related to AI, robotics and cybersecurity as well as climate change – all of which are likely to be key areas of focus in the coming years.
On the latter, as investors find it more expensive to ignore climate risks than address them, ETFs focused on sustainability and climate change will become key. According to Zacks, key funds in this space are the Xtrackers MSCI USA ESG Leaders Equity ETF, which has 314 holdings and assets of $1.7bn. It also highlights the Vanguard ESG US Stock ETF, which has 1,531 holdings and $895.5m in assets.
Valuation of assets in Vanguard ESG US Stock ETF
Millennials, as well as generation Z, could be also be a key emerging theme in the near future. According to Pew Research Center, 2019 was the year in which millennials would finally outnumber baby boomers in the US, based on US Census Bureau population projections. With this shift comes an increasing importance on millennial-focused stocks. Global X’s Millennials Thematic ETF (MILN) is capitalising on this shifting focus and includes key holdings such as Starbucks [SBUX], Apple [AAPL], The Home Depot [HD] and Nike [NKE].
During Q4 last year there were four single-theme launches that could offer a preview of what’s on the rise in 2020, according to Global X. As well as the aforementioned cybersecurity these included sustainable foods, autonomous vehicles, and gaming & esports.
The last of these, in particular, could benefit from the emergence of another important technology. As 5G rolls out in 2020, disrupting a range of industries, the technology will allow more complex gaming systems to become mobile. The intersection between gaming and 5G could prove particularly lucrative, therefore, making funds such as 5G ETF and Global X Video Games & Esports ETF all the more appealing.