By Rahul Sen Sharma, Managing Partner, and Varun Raju, Senior Analyst Index Research at Indxx.
Rahul Sen Sharma, Managing Partner (l), and Varun Raju, Senior Analyst Index Research at Indxx.
Since the first exchange-traded fund was launched in 1990, ETFs have come a long way. Their unique structure coupled with low costs and diverse exposure have registered impressive growth and maturity over time.
There has been a sharp increase in the percentage of assets allocated to ETFs over the past two years with assets in ETFs likely to outgrow those in actively managed mutual funds within the next few years. In 2020, the total AUM for global ETFs was $7.7 trillion and is currently growing at an annual rate of over 20%.
A survey conducted by PwC revealed that over half the participants expected global ETF AUM to grow to over $12 trillion by 2024 while Bank of America estimates that the ETF market will hit $50 trillion by the end of the decade.
Source: Indxx.
The COVID-19 pandemic did nothing to slow this growth. Instead, ETFs emerged stronger and proved their durability, establishing themselves as a mainstay investment vehicle for the foreseeable future. Thematic ETFs, in particular, performed incredibly well in 2020, and their AUM in the US grew by 274%, reaching $104.1 billion, up from $27.8 billion at the end of 2019. Growth has continued in 2021 with the aggregate AUM of thematic ETFs accounting for 2.2% of the US ETF industry’s $5.9 trillion AUM at the end of Q1 2021, up from the 1.9% AUM share at the end of Q4 2020.
Though the thematic ETF industry is currently dominated by US investors, interest is spiking in global markets. A survey by Brown Brother Harriman indicates that 69% of European investors and 84% of Greater China investors plan on increasing their exposure to thematic ETFs. Bloomberg Intelligence reports that AUM in global thematic ETFs rose to $180 billion in Q1 2021 and could reach as high as $500 billion within the next five years.
Source: Indxx.
What is thematic investing and what are its benefits?
Thematic investing is the identification of significant opportunities that arise from the influence of a disruptive market trend. These opportunities are leveraged through investment in businesses that are positioned to benefit positively from the adoption of this disruptive trend.
Requisitely, the identification of trends and an accurate forecast of their longevity is crucial to thematic investing. For example, cloud computing is quickly replacing the classic storage hardware of on-site servers and personal hard drives. The benefits of lower costs and enhanced remote accessibility have made it imperative for corporations to employ cloud services. Investors have recognized this fundamental shift and have sought to gain exposure to this opportunity in cloud computing. As a result, total AUM allocated to cloud computing themed ETFs in the US increased to $9 billion in Q4 2020. A notable example is the Global X Cloud Computing ETF (CLOU US) which tracks the Indxx Global Cloud Computing Index. In 2020 alone, this fund saw an inflow of over $600 million, garnering total AUM of $1.5 billion by the end of the year.
Source: Indxx.
The allure of thematic investing lies in its relatability and simplicity. The rise of thematic investing accompanies the evolving market environment where sole reliance on traditional sector/industry classifications is insufficient to cater to investor appetites. Companies engaged in fundamentally different business lines, such as local storage services and cloud computing, are often grouped under the same broad categories such as ‘Technology’ or suffer from geographic restraints such as limited exposure to promising companies from diverse global markets. Thematic investing serves to overcome these limitations. The Indxx Global Cloud Computing Index, though dominated by companies traditionally considered Technology Services, offers robust exposure to cloud computing companies across a diverse set of sectors and geographies.
Source: Indxx.
Outlook
Thematic ETFs are already bigger than any of the GICS sector ETFs and are en route to more than double in the next five years. Over the past three years, thematic ETF inflows have exceeded the combined inflows of all other sector ETFs. In the US, inflows have been primarily concentrated into disruptive technology themed funds, closely followed by those with environmental themes. In Europe, the trend is reversed whereby environmental themes derive the largest inflows. Consequently, sustainable investing has been another big draw, and AUM in ESG funds reached $1.65 trillion at the end of 2020. Four-fifths (80%) of inflows to ESG funds were domiciled in Europe and 95% of the new fund launches in Europe over the last two quarters were focused on environment-related themes. Europe accounts for half of global ESG assets although the US is close behind and has the biggest scope for expected expansion by 2022.
Notably, thematic investing differs from the broader ESG category. This difference is blurred especially in cases where certain ESG components represent a disruptive trend. The overlap is most noticeable in the environmental aspect, where topics like climate change have seeped into the mainstream focus. Themes such as clean technologies and renewable energy fall within this intersection and their collective aggregate AUM rose accordingly, reaching over $16 billion in Q1 2021 just within the US market. Political impetus has served as a catalyst to propel growth in European sustainability markets. The US, meanwhile, has lagged in implementing these policies but with a change in political administration, these topics have shifted into the spotlight. President Biden’s $2 trillion ‘American Jobs Plan’ specifically addresses climate change, and the ongoing effort to reinstate the Paris Agreement has set the stage for accelerated growth in areas such as clean energy and green infrastructure. This massive plan has a focus on long-term growth and has sparked a wave of investment in the infrastructure development theme. The Global X US Infrastructure Development ETF (PAVE US), which tracks the Indxx US Infrastructure Development Index, is a notable example due to its $2 billion net inflows in 2021. Advances to the digital infrastructure, comprising themes such as cybersecurity, 5G, and the Internet of Things, account for over $10 billion in total AUM at the end of Q1 2021.
Bottom Line
Thematic ETFs, with an agenda to achieve value over the long term, have necessitated the birth of funds with far sights on the future. Healthcare innovation, which already commands an AUM of around $12 billion in the US, along with digital assets and space, are new trends that have sparked investor interest and captured their imaginations. Although these themes are nascent and there is still room for further development, the burgeoning thematic ETF industry is primed to thrive and advance rapidly.
(The views expressed here are those of the authors and do not necessarily reflect those of ETF Strategy.)