The more philosophical among our readers might wonder why we use the categories we do when investing. For instance, why are we so obsessed with FTSE 100 stocks? For most of us, this is the benchmark UK-based index. But in truth, it’s not especially UK-focused: most businesses in the index earn most of their profits abroad. But even if it was UK-focused, why is that important?
The world is increasingly driven by mega-trends that don’t respect national borders, or even tidy asset-allocation categories. Why not invest in themes rather than geographies, benchmarks, or narrowly defined asset classes?
This is the thinking behind the growth of theme-based funds, which invest in trends such as the demographic changes associated with ageing and the rise of robotics. For me, these represent the great investment stories of the next three decades, and I absolutely want to invest in them. Still, there are pitfalls to investing in the active theme-based funds from managers such as Lombard Odier, Robeco and Sarasin.
Their fees tend to be considerably higher than standard UK FTSE-focused funds, largely because there isn’t much competition. In addition, there’s the possibility of falling victim to what academic economists call “style drift”, whereby a fund manager starts off investing in one thing and then over time shifts to something subtly different.
So we’d prefer a form of theme-based investing that mitigates some of these problems. Unfortunately, the exchange-traded fund (ETF) sector has been relatively slow to grasp the challenge of themes, perhaps because some themes don’t quite fit into the narrow focus of just one sector.
One of the first ETF issuers to address this definitional challenge was ETF Securities, with its ROBO Global Robotics and Automation ETF (LSE: ROBG), and subsequently its Cyber Security ETF (LSE: ISPY). With both of these ETFs, the manager has been replaced by an index-tracking strategy, which saves you money on the manager’s fees (actively managed funds typically charge well over 1% for their stockpicking, whereas the ETF Securities funds charge 0.80% a year).
However, the issue then becomes the index itself and how it defines the businesses within the theme. For example, should a robotics index include only a pure robotics business, or can it include a larger group that has some robotics in its product mix (such as engineering giant ABB, which is the eighth-largest holding in the ETF Securities fund)?
iShares, which has just launched four new thematic ETFs, uses an external classification system to identify more precisely which industry a firm operates in. The funds are intriguing: they consist of the Ageing Population ETF (LSE: AGED), the Automation & Robotics ETF (LSE: RBOT), the Digitalisation ETF (LSE: DGTL) and the Healthcare Innovation ETF (LSE: HEAL).
All four have a total expense ratio of 0.40% and each of the indices equal-weights the constituent stocks, which gives more weight to the smaller businesses in the index (great if you want a more growth-orientated, although more volatile, portfolio). Overall, they look an excellent addition to the iShare range.
The ETFs still can’t avoid all definitional problems. Take the Ageing Population ETF, which has Hargreaves Lansdown in its top-ten holdings. The fund supermarket will no doubt benefit from an ageing society – via oldies with lots of liquid wealth – but some investors might have hoped for a more direct connection to the theme of an ageing society, such as Zimmer frame manufacturers.
However, I am probably guilty of nit-picking here. There’s no getting away from the fact that impending demographic shifts are likely to have profound consequences for investors. You could invest in a health care or pharmaceuticals sector ETF and pay slightly lower fees, but the ability of these theme-based, bespoke indices to delve into other areas is a real plus.