Niche ETFs May Not Be Doomed

July 14, 2011

It surprises me how esoteric some funds are these days. But the success of some of these niche sector funds surprises me too.

All the obvious economic sectors, such as basic materials and telecommunications, were covered long ago. So, these days, issuers are pushing into very specific industries, creating ETFs that get at a market with the precision of a scalpel.

Take, for instance, the Global X Fertilizers/Potash ETF (NYSEArca: SOIL) launched in May, or the First Trust Cloud Computing ETF (NasdaqGM: SKYY), which launched just last week. Those funds are symbolic of an era when issuers are competing to provide ever-more-targeted access to specific industries, both in the U.S. and abroad.

I’ve questioned whether those funds will attract long-term assets. I often come across funds languishing with just $20 million in assets and wonder if they’ll ever make it out of that rut. Is there really a demand for all these theme funds?

To help answer that question, I took a look at two years of flows data on industry-specific ETFs. A lot of these ETFs and ETNs are out there these days—I included 125 in my analysis—and they cover everything from silver miners to automakers to the water industry. So I figure there’s a lot of diversification in that sampling, which means these flows numbers aren’t just people chasing the latest hot industry.

So, what’s the bottom line? Over two years, and notwithstanding the occasional dud ETF, funds that offer exquisitely calibrated exposure have pulled in some pretty big assets. All together, industry-specific ETFs have hauled in $13 billion since mid-2009.

Interestingly, there’s been a big divergence between U.S. and internationally focused funds.

Of the $13 billion total that flowed in, $10 billion went to ETFs that invest in international equities. That amounts to an increase of 41 percent in assets under management for the international ETFs, while the U.S.-focused funds saw a smaller gain, of 15 percent.

 

Net Flows ($, mm)

AUM ($, mm)

% of AUM

U.S. Equity

2,925.17

18,917.33

15.46%

International Equity

10,120.45

24,524.83

41.27%

Total:

13,045.62

43,442.15

30.03%

 

Some of the flows into international funds are clearly a direct bet on the growth of foreign economies.

Take the PowerShares Emerging Markets Infrastructure Portfolio (NYSEArca: PXR). As you might guess, the fund holds infrastructure companies based in countries like China and Brazil. But other funds, such as the Market Vectors Rare Earth/Strategic Metals ETF (NYSEArca: REMX), just offer a better reflection of the targeted industry itself. REMX is heavy in Canadian and Australian names, but also has significant U.S. exposure.

To say the least, these industry-specific funds seem to be catching on, even if it’s not happening overnight.

Case in point: Of the funds launched in 2011, none has much more than $50 million in assets. But many funds launched in 2010 have topped $400 million in assets, and some funds launched in 2009 have more than $2 billion in assets.

For those industry-specific ETFs that have low assets today—the ones that aroused my skepticism in the first place—it may just be a question of being in it for the long haul.

That’s certainly how companies like First Trust justify niche funds like its First Trust Nasdaq CEA Smartphone ETF (NasdaqGM: FONE). They say they’re not going anywhere and, moreover, are sure they can run their funds efficiently enough so that they don’t have to have blockbusters to make money. For the record, FONE has gathered around $16 million since its launch in February of this year.

At the end of the day, there’s no denying it: Industry-specific funds are carving out a real space for themselves in the ETF industry.

 

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