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ETFS and thematic investing

Will More Advisors Shift Client Assets From Mutual Funds to ETFs?

Exchange Traded Funds (ETFs) are a critical part of the emerging trend of thematic investing. Thematic investing breaks down investments by themes, which refer to specific risk areas to which the investor wants to gain exposure. Themes can be of any type; geography, commodity, industry. ETFs come in to play because the firms producing and marketing them have made themed ETFs, focused on specific industries, regions or sectors. This is a perfect tool for allowing investors to access the markets they want, at a relatively low cost.

What are ETFs?

ETFs are low-cost, passively managed funds that are traded on an exchange like an equity. They have a typical launch value of 100 which grows or shrinks depending on the funds returns. For example, an S&P500 ETF will buy stocks to track the proportions of different shares in the S&P500 index, with the aim of replicating the returns of that index. The fund will occasionally make trades in order to reflect changes in the composition or weighting of the index but for the most part holds a stable portfolio of assets. This allows investors to benefit from price changes in the index.

More specific, niche ETFs also exist. For example, you might have an American Oil and Gas ETF that tracks only the stocks of those companies that are involved in the oil and gas market in the US, in order to replicate their returns. This may or may not involve tracking a specific index. More obscure ETFs do not track indexes, and some are built on very broad investment ideas, such as global equities or global banks. These will hold a selection of worldwide equities. Banks like Saxo offer a broad range of ETFs to investors.

What is thematic investing?

Thematic investing involves selecting one or several themes that you use to guide portfolio distribution. For example, lets say you are bullish on the future prospects of the global shipping industry. It is not immediately clear what you should buy, assuming you have decided to buy a fund rather than individual stocks. If there are 20 leading global shipping firms, buying all of their stocks may be difficult due to the different markets involved, the problematic nature of carrying out research and son on. Alternatively, it’s unlikely dedicated active funds exist for such a specific investment theme, so mutual funds are not an option.

A (hypothetical) global shipping ETF would be an ideal solution. Such a fund would probably hold all of the relevant stocks, and maintain them in proportion to their relative contribution to the overall shipping market. This rebalancing differs from active management, asides from its lower fees, because the aim of the fund is not to enhance returns beyond the market rate but to replicate it accurately.

Why are ETFs well-suited to thematic investing?

ETFs are particularly well-suited to thematic investing because they are cheap, and because thematic ETFs exist. In theory, it would be perfectly possible to use actively managed funds or single stocks to …