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Thematic ETFs: Not Smart Beta For Not Smart Investors

Posted on: 06.08.2016

Smart Beta ETFs are being launched by the boatload.  According to Dan Weil,  factor based funds and thematic ETFs “comprised half of all ETF launches so far this year”.  His article, ‘See A Trend? Make an ETF’ doesn’t break down the difference between the two (factor based / thematic) but it is important to understand the difference.

Factor based funds focus on a ‘factor’ which is mathematically and statistically based and backed up with academic research.  The constituents of the fund can be systematically selected based on the factors, this leaves out human choice and ensures that the establishing factor is followed.  That is smart beta.

Thematic ETFs are a totally different animal.  If smart beta is a jaguar, thematic ETFs are a turkey.  They focus on some macro trend, like obesity, millennial buying power, clean energy, or may legalization of marijuana (there is not yet a marijuana ETF but I’m sure a marijuana ETF is coming soon).  For example Global X, who has whole line up of ETFs, launched a ‘millennials’ ETF in May (MILN).  The concept behind the fund is to capitalize on the miillenial generation of those born between 1981 and 1997.  This is the largest generation in US history, totaling 75 million, and earning about $2 trilion a year.  They’ll also be inheriting $42 trillion, says Jay Jacobs, director of research for Global X.

How do we know what millennials will be buying?  Well we don’t know for sure, but we can follow the trends and make a guess.

Millennials Thematic focuses on eight industries: social and entertainment; clothing and apparel; travel and mobility; food, restaurants and consumer staples; financial services and investments; housing and home goods; education and employment; and health and fitness. The ETF’s five biggest holdings are LinkedIn Corp. (4.9 percent), Amazon.com Inc. (3.5 percent), Fiserv Inc. (3.2 percent), Facebook Inc. (3.1 percent) and Intuit Inc. (3.1 percent).

Janus has also launched a series of thematic funds, which were created from a series of 3 screens; Obesity ETF, Organics ETF, Health and Fitness ETF, and Long Term Care ETF.  The three screens they used according to Nick Cherney, head of exchange traded products at Janus Capital Group are:

  1. a theme where it would be instantly agreed by everyone that the theme would persist for multiple year
  2. Some that was narrowly definable and investable
  3. Commercially viable

The research sounds so rigorous (not).  I can’t even begin to image how the

An Index Fund Will Capture The Profitable Theme

If companies notice a profitable trend, they will capitalize on it.  Large or small, they’ll move into the trending space.  If they are small they will grow with the trend.  Another way of saying it is that businesses will adapt into the trending economic climate.

We can all agree millennials will have an impact on the economy.  Current firms anticipate this and will position themselves accordingly.  But if our unanimous agreement is wrong, firms will need to capitalize on something else.  Its the nature of economics and to be successful firms need to capitalize on what is profitable.   If companies notice a profitable trend, they will capitalize on it.  Large or small, they’ll move into the trending space.  If they are small they will grow with the trend.

Currently 3 of MILN’s top 10 holding’s are SP500 constituents; Amazon, Alphabet, and Facebook.  Many of the other holdings are internat and shopping related which you can get exposure to via basic index fund.

Ultimately an index will capture the return of a theme, if the theme is large enough.   Its more sound to make this bet, which leaves the ‘best’ theme up to the market than it is to

Emotional Appeal Is An Easy Sell

The Director of ETF Research for Morningstar, Ben Johnson, says “The ETF industry has dusted off the spaghetti bazooka and said, ‘ready, fire, aim,’ to see what it can get to stick to the wall”.  He further notes that the funds’ themes are essentially based on news headlines, and their fees are steep.

These funds largely appeal to the masses… amateur investors who don’t stick to simple systems or market cap buy & hold.  From a business perspective the ETF industry is probably on to something profitable.  Simple things, that people can rationalize easily and ‘see’ are simple to sell.  If I needed to sell ETFs to the general public, a theme etf would be my choice item to rake in the revenue.  It reminds me of a good article of how Smart People Are Sold Dumb Stuff.

As an investor, I wouldn’t put a penny into any thematic etf.  Part of my focus with RealSmartBeta.com is to discern sound, academic, systematic funds from ‘noise and gargbage’.  Thematic etfs are the latter.

SFactor based ETFs are

Corey Philip

Corey Philip is the founder of RealSmartBeta.com. His focus is on expanding investor knowledge of Smart Beta ETFs and quantitative investing. Learn more about Corey in the 'ABOUT' section of this website.

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