How to Talk with Clients About Thematic ETFs

Advisors that have been using exchange traded funds for years are seeing evolution at the product level. When these funds initially burst onto the U.S. investment scene nearly three decades, the idea was to provide market participants with an alternative to the stagnant, once-a-day pricing of active mutual funds and index funds.

As was the case with the earliest index funds, the first-to-market ETFs weren't particular glamorous. The first in the U.S. was the SPDR S&P 500 (NYSEARCA:SPY). Follow ups were comparably “unsexy”, including ETFs linked to basic broad market benchmarks such as the Russell 1000, MSCI EAFE and MSCI Emerging Markets indexes.

From there, issuers delivered sector and industry funds. Hand it to ETF issuers because they're an innovative group. Equity ETF evolution didn't cease with sector and industry funds. Rather, those products served as springboards for the ongoing thematic revolution.

If you're like me and have been involved with ETFs in some form for awhile – I've been trading, writing and drilling down on ETFs since 2008 – you're apt to remember some absolutely wacky thematic concepts. Funds focusing on global fisheries, restaurants and companies with significant exposure to sports sponsorships, among others, have all come and gone.

Fortunately, the thematic ETF landscape is maturing and that maturation process is bringing with it more viable funds addressing more relevant concepts, plenty of which are delivering impressive performance. Add those factors up and it's plausible that advisors will be having more conversations about thematic ETFs, particularly with younger, risk-tolerant clients.

Time to Talk Thematic

Gone are the days when thematic ETFs were thought of as too much of a good and not worthy of investors' capital. Data confirm as much. At the end of last year, the US-listed universe of thematic ETFs had $104.1 billion in combined assets under management, or nearly quadruple the $27.8 billion at the end of 2019.

With that growth forecast to continue, advisors need to strategize when it comes to discussing thematic ETFs and deploying such funds in client portfolios.

“One of the most important aspects of implementing thematic ETFs is to clearly determine an investment thesis and time horizon,” according to First Trust research. “Establishing appropriate entry and exit points up front may help manage clients’ return expectations and avoid making emotionally-charged behavioral mistakes. For example, an investor with a long-term time horizon may view a pullback in a high conviction thematic ETF as an opportunity to buy additional shares at a lower price instead of a signal to sell out of their position.”

Something else to keep in mind is that while there are still ETFs out there that probably aren't applicable for nine out of ten clients, there are still plenty of thematic ETFs that are. Think cloud computing, cybersecurity and e-commerce, among others.

“Many ETFs have more nuanced methodologies and exposures than one might initially expect. In our opinion, it’s important for investment professionals to do their homework when considering a thematic ETF to understand its industry, sector, and geographical exposures,” notes First Trust. “These exposures should then be analyzed in the context of an investor’s overall portfolio allocation.”

Ticket to Talking With Younger Clients

Thematic ETFs are useful to advisors on another front: Connecting with younger clients. In fact, the thematic conversation pares well with another topic younger clients prioritize, that being sustainable investing.

“Both investment philosophies inherently focus on a long-time horizon,” says Global X. “Looking at investor demographics, both thematic investing and sustainable investing notably appeal to younger investors: 83% of millennials said they were 'extremely interested' or 'very interested' in thematic investing according to a Global X-commissioned 2017 survey, while 86% of millennials expressed interest in sustainable investing, according to a Morgan Stanley survey in the same year.”

Remembering that millennials and Gen Z are tech savvy and looking to investor in a manner reflective of their values – and that they'll be on the receiving end of the much ballyhooed transfer of wealth – discussing thematic ETFs with these clients is both appropriate and important.

Related: Tips for Transacting in Small ETFs