When & How To Use Niche ETFs

May 16, 2017

Understand The Risks

Adding niche ETFs to a portfolio can help diversify it, working as a risk management tool. Better diversification should mean lower overall portfolio risk.

The flip side is that niche ETFs could also increase the risk of a portfolio if you end up adding too much exposure to single stocks. By design, niche ETFs are concentrated, narrower portfolios, and can carry a lot of weight in a handful of stocks. Any underperformance in one of the top holdings could drag your overall returns.

“If used as, say, adding floating rate securities to manage your interest rate risk in fixed income, these ETFs can help you manage portfolio risk,” Engelbart said. “But you could be adding more idiosyncratic risk to your portfolio, too, if you have ETFs that have 10-20% weighting in a single stock.”

Know Where Niche ETFs Fit Best

The best application of niche ETFs is the one that best suits your investment needs and goals. That said, consider these two broad possible applications. First, it’s harder to argue niche ETFs as strategic allocations rather than tactical.

“Satellite usage makes a ton of sense in niche ETFs,” Engelbart explained. “They’re great to pair with broader exposures.”

For example, you may own emerging market stocks. You may also be bullish on India’s demographics and want added exposure to India’s small-cap and infrastructure stocks. Adding niche ETFs tapping into those segments to your broader emerging markets ETF allocation makes sense, he says. This is one of the common ways CLS incorporates niche to the portfolio.

The same applies to cybersecurity, or robotics—adding narrower exposures to your broader-growth technology ETFs. Niche funds are great tactical overlays, Engelbart notes.

But that’s not the only use. The example of MILN, again, or the Long-Term Care ETF (OLD), shows that niche exposures can also play out in the longer term. Holding on to these funds in your broader equity bucket may make strategic sense.


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