Using Thematic ETFs

November 15, 2018

Jon MaierDemand for income—and specifically, dividends—has been a hot theme in recent months as investors look for ways to generate income in a rising rate environment. Global X has some of the highest-yielding dividend ETFs on the market today—funds like the Global X SuperDividend US ETF (DIV) and the Global X SuperDividend ETF (SDIV), yielding 6.3% and 8%, respectively. Beyond dividend investing, the ETF issuer is well-known for its thematic ETFs.

Jon Maier, formerly known as one of the biggest ETF strategists while senior portfolio manager for ETF business at Merrill Lynch, and now Global X’s chief investment officer, tells us how to best implement dividend ETFs in a portfolio, and more broadly, thematic ETFs.

 

ETF.com: One of the big themes this year has been generating income. Global X has a line of dividend ETFs that deliver some of the highest yields in their respective segments. What about your approach to dividends works so well?

Jon Maier: There's a need for yield across many segments of the population. The baby boomers, for example, require income, but equities are perceived to be too risky in and of themselves. So, we’ve created different ETFs suitable for different types of clients and different types of environments.

With certain types of yield come certain types of risk. Nothing is free. Currently, in a rising interest rate environment, one of the areas I think is interesting is preferred ETFs. While they're technically equities, they're bondlike. They're issued at par. They're yield-bearing. They usually come with fixed distributions. They've also got a credit rating. They generally have a low correlation with equities and more traditional fixed income, so they offer diversification during periods of market volatility.

Over the past five years, the S&P's preferred stock index had about a 50-60% correlation with the Bloomberg Agg, and a roughly 30% correlation with the S&P 500. Having preferreds as a portion of your overall portfolio makes sense, even in a rising rate environment. ETFs like the Global X U.S. Preferred ETF (PFFD) and the similar iShares U.S. Preferred Stock ETF (PFF).

Other types of high-income-yielding ETFs include funds like the Global X SuperDividend US ETF (DIV) or the Global X SuperDividend ETF (SDIV). DIV has a large amount of utilities, and that’s providing some of the high income within that ETF, as well as mortgage REITs.

ETF.com: Is adding one SuperDividend-type ETF to your portfolio enough if you’re seeking income? Or do these strategies work best in conjunction with other funds?

Maier: Whenever you're buying one thing, it comes with risk at some point in the cycle. I like to pair certain securities with other securities. We've created an equity income model that includes SDIV and DIV, and rounds it out with some other less income-oriented sectors for more complete exposure.

This portfolio is created as an illustration on how to use some of our ETFs in a broader portfolio. But it's always wise to diversify. While you're going to reduce your overall yield by buying less high-yielding sectors, you're diversifying your overall risk.

ETF.com: Is that the biggest risk to chasing income—losing sight of other intended or unintended risks?

Maier: Yes, it's always a risk. Certain clients just want the highest possible income, but we try to educate them that you should look at income in the context of a broader portfolio, and mitigate some of the risk during different types of cycles.

ETF.com: Global X’s biggest ETF is the Global X Robotics & Artificial Intelligence ETF (BOTZ). Why has thematic investing grown so fast?

Maier: Why have thematic ETFs done so well? You have to think about how things come out, the adoption of certain new technologies, whether it be fintech, robotics, autonomous vehicles. Some of these things are changing a traditional paradigm. If you look at fintech, look at how we pay our bills—digital payments. We’re transacting on our phones. Everything's moving rather fast. Fintech is changing the traditional sector of financials.

Look at robotics and artificial intelligence. Back in the '70s, robots just did one function; they went up and down in assembly lines. They didn't sense anything that was around them, they didn't learn anything. That’s changed, and you’re seeing different applications of robotics in industrials, in technology. We're trying to look at companies that are focusing on these specific exposures that have a high revenue coming from those technologies.

ETF.com: What’s the best way to implement themes in a portfolio? How do you manage risk in thematic ETFs?

Maier: My primary job historically has been a portfolio manager. Risk has always been something front of mind. In any portfolio, you want to diversify. You can use a portfolio of different themes—we call it a thematic disrupters portfolio—as part of your overall portfolio.

Clients are looking to be exposed to changing paradigms. They're looking to be exposed to new technology. They don't necessarily realize some of the risks associated with buying some of the high-growth companies within these ETFs. While we believe the nature of the underlying businesses are structural, on a short-term basis—like we've seen recently—prices certainly can come down. Being that they can come down, you have to manage risk, and that’s specific to the risk appetite of a particular client.

A portfolio of thematic disrupters can be scaled into a more traditional asset allocation. In a moderate portfolio, if you have 5-10% of your global equity exposure to thematic disrupters, it may add or take away some overall return, but not too much. You may get 0.50-1.0 percentage points of excess return based on that exposure. Or, if the markets go the other way, that's not something that's going to blow up their overall portfolio.

Contact Cinthia Murphy at [email protected]

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