Major asset managers seek bigger share of thematic ETF market as number of offerings increases

Thematic exchange-traded funds (ETFs), which have seen dramatic growth over the past decade in North America, are poised to explode in popularity in the coming years. These funds, which focus on market niches versus traditional industry sectors, have been the playground for smaller, startup firms. But giant asset managers now want a bigger slice of this pie, which still only makes up about 2 per cent of total equity ETF assets in Canada and 2.6 per cent in the United States.

New York-based BlackRock Inc., the global ETF leader known for its iShares passive index funds, recently signalled a more aggressive foray into “megatrend” thematic funds with the launch of its U.S.listed iShares Emergent Food and AgTech Multisector ETF IVEG-Q and iShares Blockchain and Tech ETF IBLC-A.

In Canada, BlackRock recently introduced four thematic RBC iShares ETFs that are clones of existing U.S. funds. In January, BMO Global Asset Management launched a batch of ETFs, including five tracking “innovation” indexes developed with U.S.based Ark Investment Management LLC. Ark founder Cathie Wood, a poster child for disruptive innovation ETFs, also runs funds sold by Emerge Canada Inc.

“It wouldn’t surprise me if, in the future, the absolute number of thematic ETFs comes to dominate” traditional core, passive index funds, says Daniel Straus, director of ETF research and strategy at National Bank Financial Inc.

There are currently 167 Canadian-listed thematic ETFs, versus 177 passive market-capitalization and equal-weight funds, he says. In the U.S., there are 329 thematic offerings, versus 598 market-cap and equalweight ETFs.

Passive, core-index offerings will continue to have most of the assets, he says. Because it’s difficult to dislodge incumbents in that space, “any new fund provider is not going to bother trying and will instead come up with an original theme.”

Although the definition for thematic funds can vary, they typically focus on a subsector, such as cybersecurity, or multiple sectors, such as an infrastructure ETF holding everything from utilities to industrial and materials companies.

However, most of the recently launched thematic ETFs tend to have a technology or growth bent, while some older ones have concentrated on niches ranging from water infrastructure to shipping and airlines.

Investors typically own the ultra-cheap, passive, market-cap weighted ETFs for the core of their portfolio and add thematic ETFs for “the spicy sauce,” Mr. Straus says. “But thematic ETFs can be extraordinarily risky, so the position size is the important thing to monitor.”

For example, the high-profile U.S.-listed Ark Innovation ETF ARKK-A soared 157 per cent in 2020, but lost 23 per cent last year and is down 54 per cent so far this year. Technology-oriented stocks have been beaten up amid rising interest rates.

The jury is still out as to whether the wild, roller-coaster returns in many thematic ETFs will make investors gun-shy, Mr. Straus says. “Longer term, I think that even as the markets go through a tough time, there will be some themes that will flourish.”

A potential new theme for ETFs could be energy storage, he says, because power from renewable resources such as wind and solar needs to be harvested for use when needed. An agricultural technology ETF, which could invest in small-cap companies using drones or robots to assist in farming, could be another.

For investors spooked by volatile markets, themes benefiting from a recessionary environment and inflation could resonate, he says. That would include ETFs focused on natural resources and agriculture, as well as infrastructure, which could benefit from potential government spending to deal with a recession.

Steven Leong, director and head of iShares Canada product for BlackRock, stresses that the firm’s product launches are not driven as a “tactical answer to any particular set of market conditions.” However, there are already iShares ETFs focused on materials, agriculture and infrastructure on its product shelf.

BlackRock’s recent thematic focus stems from a “megatrends framework,” Mr. Leong notes.

“There are five key foundational themes, which are long term and transformational in nature,” he says. “We are talking about themes that are potentially disruptive of business models … and can lead to important innovations.”

Those megatrends include technological breakthroughs, such as in cybersecurity and cloud computing; demographics and social change, which include areas such as genomics because of longer lifespans, and rapid urbanization, particularly in developing countries, he says. Climate change and resource scarcity, as well as emerging global wealth, which is about the growing middle class in developing markets, are also themes.

Some of those trends are reflected in the recent Canadian launch of iShares Exponential Technologies ETF XEXP-T, iShares Global Clean Energy ETF XCLN-T, iShares Genomics Immunology and Healthcare ETF XDNA-T, and iShares Cybersecurity and Tech ETF XHAK-T.

These four ETF themes are not new for BlackRock as a firm, but are now being introduced to Canada because “we see that our clients are seeking these exposures,” Mr. Leong says.