Thematic ETFs May Redefine Sector Investing

Global X is breaking new ground with a quickly growing lineup of thematic ETFs the firm believes could redefine sector investing in the future. We’re talking about funds such as the Millennials Thematic ETF (MILN), the Longevity Thematic ETF (LNGR) and the S&P 500 Catholic Values ETF (CATH), to name a few.

CEO Bruno del Ama and Vice President/Head of Research Jay Jacobs tell us why Global X is making such a push into theme-based investing, and why themes are the new sectors.

ETF.com: Global X today has 11 thematic ETFs, and a dozen or so more in registration. It's not often we see a blockbuster success in a very narrowly focused fund. Why such a push into themes?

Bruno del Ama: Contextually, we have, as of today, about $500 million in thematic ETFs, primarily between the Social Media ETF (SOCL | B-47) and five resource ETFs. Thematic investing is about capitalizing on future trends.

If you think about how people have traditionally invested—call it the Select Sector SPDR view of the world—they’ve long invested in sectors, but no one thinks of sectors as niche.

Why? Is it because it's sort of a broad theme? The reality is that a lot of people say they want to invest in technology, and they think of technology as a proxy for growth stocks. That was true a couple of decades ago. It really isn’t quite true today.

Today you’ll find social media companies and big data companies in a tech ETF. But you’ll also find, for example, personal computer companies—PCs—and that’s a very mature industry, very slow growth.

On the flip side, if you think about the health care sector, which tends to be much more defensive, anticyclical, you're going to have companies like biotech names that have a lot more of the technology-type characteristics of growth and innovation.

That’s where thematic investing comes in. We think about thematic as a way to capitalize on future trends, on where the world’s going. Thematic investing started as an institutional trend. Very recently, it's migrated to the private banking space.

So if you're a wealthy individual with a private banking account at Goldman Sachs or Merrill Lynch, UBS, Morgan Stanley, you have access to the research those shops have been building on thematic investing for their clients. And all of those shops, for example, have identified millennials as a theme they think their clients should be positioned for.

We're bringing themes like millennials, for example, to everyone, which we think isn’t niche at all. We think it’s actually a very broad category, much like a sector. It’s a very broad consumer category, but at a cross-sector sort of analysis. We’re positioning the portfolio to bet on what millennials are spending, and the ETF wrapper is a very good mechanism to democratize what until recently has been an institutional investment trend.

ETF.com: Lee Kranefuss recently told me thematic ETFs are like trying to chase a hot stock or write a hit song. I'm guessing you completely disagree with that view, but the question is, how enduring are these themes?

Del Ama: It's very difficult for anybody to challenge Lee Kranefuss, because he's a brilliant man and he has a great perspective on our business. Now, I’ll tell you that I am friends with Kranefuss’ co-partner and co-chairman on his new investment vehicle, 55 Capital, Vinay Nair, and we've talked about our thematic ETFs and he likes them. But he and Lee would certainly make a distinction between a short-term one-hit theme, and a long-term investment theme. 

If you go through how they actually invest, they actually have a system that rotates across ETFs based on a number of signals. I’d argue the investment firm he's building is very much of the view that thematic investing is a great way to think about the world.

ETF.com: Fair enough. Let’s talk about whether these themes are long-term trends. Are they appropriate for long-term investors?

Jay Jacobs: There are really three things we look for in a thematic trend before we have conviction about this being a potential ETF. First, is it highly likely that this trend will play out the way we expect it to?

If you think about the millennials ETF or the other two we launched recently—the Health & Wellness ETF (BFIT) and the Longevity ETF (LNGR)—they all fall in our people category. And one of the good things about people is that they’re actually fairly predictable if you're looking at things like consumer behaviors and demographics. It can happen slowly, but it can be very predictable.

Secondly, we look for is investability. Are there investments that are liquid enough that have high exposure to these themes? And the third thing we look for is the time frame. Because even if it's investable and it's highly likely to happen as we expect it to, if it's going to happen over a very short time frame, getting the timing right becomes a lot more important, and that reduces the likelihood of being able to generate returns from that thematic idea.

ETF.com: How do you pick a theme?

Jacobs: Looking at it top down, we have a pretty comprehensive suite of themes that look beyond the traditional. The most basic way of looking at thematic investing is from a macroeconomic perspective—people talk about themes like rising interest rates and positioning their portfolios for those themes.

But we’re looking beyond macroeconomics to important structural changes in the macro environment, such as changes in people, changes in supply and demand for specific resources, emerging technologies and even values-based investing. That’s the starting point.

When we think about expanding our suite, we don’t look for one-off launches, but to provide access a new category—we think of these themes sort of as the new sectors. We think about people as a sector within what's driving the global economy.

So, how do you invest in different parts of what's really driving changes within people? It's changes in generations, it's changes in consumer behaviors, it's demographic changes with longevity. We’re trying to offer a comprehensive set of options within these important macro themes.

ETF.com: Now how do investors use these thematic ETFs in a broader portfolio? Are they growth strategies, by and large?

Jacobs: We see these thematic ideas as primarily growth innovators. They're long term in nature and they're designed to generate returns. So, there're various places they could fit in a portfolio. The millennials ETF, for example, is U.S. equities only, so it can fit nicely in the U.S. sleeve. And it's sort of all-cap.

But some of our themes are global in nature. The longevity theme is a global theme, where people are living longer around the world. So it fits in that equity bucket, but more global. Better yet, we think people should just have a thematic or an unconstrained bucket where these themes can fit.

What we like about themes is the unconstrained approach—you’re not stuck in this gridlike approach where you have to look at specific geographies and specific sectors, but instead, the theme can move with where the opportunity is.

ETF.com: Is overlap exposure a concern? Investors could end up owning, say, Whole Foods through the health and wellness ETF as well as through another consumer staple ETF that they already have. How do you manage that?

Jacobs: McKinsey wrote a really excellent report on thematic investing and its increasing usage among institutional investors. One of the things they point out is that they believe the best themes are actually those that are reinforced by multiple themes at the same time.

So the health and wellness theme is a theme on its own, but it's also somewhat of a theme within millennials. We've seen that millennials are more likely to spend money on healthy food than other generations. We think that only makes the theme stronger, the fact that there's other themes converging together to support each other.

ETF.com: What’s the biggest risk in choosing to go with thematic ETFs?

Jacobs: The good news is that our approach to thematic investing is broad. We don't think we're taking on too much idiosyncratic risk. It is relatively diversified. But when you’re looking at thematic investing, I think timing is important. The earlier on in a trend you are, the better the potential is, especially if the rest of the market hasn't quite caught up with it. Timing is important.

ETF.com: I would think being first to market would be crucial to success here. A millennials ETF, a longevity ETF, a nanotechnology ETF in the pipeline—is being first critical?

Del Ama: I think that’s something that’s generally true more often than not for the ETF landscape. But there are two elements here that are very important. You need to have a good process when you’re building the ETF. Being first is great, but a solid, repeatable process matters.

The other piece that makes a difference is that there have been other firms in the market that have done a little bit here and there on thematic, but there really is no firm that has truly embraced thematic as a sort of comprehensive, consistent, thoughtful approach, offering building blocks that can be used effectively to build portfolios. That’s what we’re doing.

Contact Cinthia Murphy at [email protected].