ETFs Continue To Slice Market Thinner

April 20, 2016

A common refrain we hear as more and more ETFs come to market is, “How many ETFs do we really need?”

With more than 1,800 exchange-traded products listed in the U.S., compared to more than 8,000 mutual funds, there would seem to be enough, but that also depends on how thin you prefer your markets to be sliced.

The roots of index investing, and even the 22-year old SPDR S&P 500 (SPY | A-98), reside in the idea of capturing broad pieces of the stock, bond and even commodity markets. But as the ETF industry has evolved, all the low-hanging broad market exposure has been captured in an ETF wrapper.

Narrowing Focuses

In today’s 21st-century ETF market, we have been seeing a move away from broad-type and into niche exposures as ETF issuers slice and dice financial markets in new ways.

We are approaching market slices thinner than the ginger that is served with wasabi and your sushi. Consider some of the novel and highly focused ETF launches we have seen in recent months:

  • The Sprott Buzz Social Media Insights ETF (BUZ) launched this week on Tuesday. The fund tracks an index that selects and ranks companies based on positive sentiment about them, and on volume of chatter about them in social media.
  • The Global X S&P 500 Catholic Values ETF (CATH) also launched this week. The fund essentially tracks a screened version of the S&P 500 that includes companies that are acceptable under social responsibility standards set forth by the United States Conference of Catholic Bishops.

Drone ETF Takes Flight

  • The PureFunds Drone Economy Strategy (IFLY) came out last month, and tracks an equity index of global companies related to the drone industry. IFLY debuted in tandem with the PureFunds Video Game Tech (GAMR), which—as advertised in its name—follows an equity index of global firms that support, create or use video games.
  • The SPDR SSGA Gender Diversity (SHE) also made its debut in March, offering investor exposure to a market-cap-weighted index of U.S. large-cap companies with a relatively high proportion of women in executive and director positions.
  • The Market Vectors Generic Drugs (GNRX) came to market earlier this year, paring the pharmaceutical industry down to U.S. and international companies that have a primary business focus on the generic drug industry.
  • The SPDR S&P 500 Fossil Fuel Free (SPYX) launched last November, offering investors a way to exclude companies with known fossil fuel reserves.
  • The Etho Climate Leadership U.S. ETF (ETHO) is another newbie, coming to market last November, which tracks an index that selects U.S. equities of companies that exhibit the least carbon impact within their respective industries.

Should Investors Consider These?

The underlying question is whether these thin slices of the market are something investors should consider, or if it is more akin to the stock picking that flies in the face of passive investing.

“Narrow niche funds are poor substitutes for big broad equity ETFs like SPY, or even for the pure-play-sector ETFs within the related sector, like XLK [the Technology Select SPDR (A-94)],” said Paul Britt, senior ETF analyst at FactSet.

“Part of the reason for this is that the best pure-play index ETFs are incredibly good at what they do—cheap, tax-efficient exposure that’s likely to beat active management in the same space,” he added.

However, Britt says there is merit in owning a group of companies focused on one area rather than trying to pick the individual winners in those businesses.

Alternative To Stock Picking

“Instead, the niche plays are worth considering as an alternative to owning single names outright—for example, to buy a handful of gaming stocks using GAMR rather than just Nintendo. If you’re not interested in Nintendo in the first place, than GAMR probably isn’t for you either,” he said.

We don’t expect ETF product innovation to slow down or even stall going forward. There are countless other market niches to be exploited, and some will follow the successful footsteps of the $715 million PureFunds ISE Cyber Security ETF (HACK | C-32).

That said, these niche types of ETFs have an uphill battle in gathering assets. HACK was an exception to the pack. There’s no question that a lot of this ETF spaghetti will not stick to the wall, so investors beware.

Drew Voros is the editor-in-chief of ETF.com. He can be reached at [email protected].

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