Thematic ETFs offer cheap variety

Share this

Exchange traded funds have never been more popular – there is now more than £291 billion under management in European-listed ETFs. Since the first one launched in Europe in 2000, they have evolved to cater for even the most arcane of tastes.

Now, there's a huge range of specific indices drilling down to any sector or geographical region, with an increasing number of 'thematic' ETFs launched every month for the niche investor. Indices have launched tracking companies involved in everything from global clean energy to timber and forestry.

One type of thematic ETF is Shariah-compliant, designed for Muslim investors. IShares, the BlackRock-owned ETF provider, offers three Islamic funds. These track MSCI indices focusing on applicable companies in the emerging markets, the US and worldwide.

Db X-trackers, the ETF platform of Deutsche Bank, also offers a range tracking S&P Islamic-screened indices, plus an ETF tracking a Dow Jones Islamic index.

These Islamic indices adopt a tough screening process to follow explicit Shariah investment criteria. Companies are screened according to business activity, such as how much they borrow from other companies, then any groups involved in alcohol, tobacco, pork, financials, weapons and entertainment are ruled out.

But the performance figures aren't good. The iShares MSCI Islamic range has not performed well since its inception in September 2007. The MSCI World Islamic ETF has lost 4.57%, while the MSCI Emerging Markets Islamic ETF has shed 12.22% of its value since its launch in 2007. Only the ETF focusing on US Shariah-compliant stocks has gained a return – but even that stands at a paltry 1.44%, as at 21 March.

The db X-trackers ETFs fare better, although returns are still something of a mixed bag. Since their inception in July 2008, the Dow Jones Islamic Titans 100 ETF has gained 4.28%, the S&P 500 Shariah ETF 8.91% and the S&P Europe 350 Shariah ETF 12.07%. However, the Japanese-focused ETF has shed 1.1% of its value.

Manooj Mistry, head of db X-trackers in the UK, says these Shariah-compliant ETFs have yet to take off, but that this has more to do with the relatively small size of the ETF market itself. David Bower, marketing director of iShares Europe, admits there has been "less take-up of the Shariah range than other exposures".

Why? One reason could be cost. While ETFs are generally cheap investment vehicles, thematic ones sit at the higher end of their cost spectrum.

Caroline Shaw, an investment manager at Courtiers, adds that themed ETFs are "without a doubt" more expensive, and that could be why they haven't enjoyed the same success as some of the funds offering a broader exposure.

For example, the range of iShares Shariah-compliant funds charge from 0.5% to 0.85% for the emerging markets ETF. The db X-trackers S&P Global Infrastructure charges 0.6% TER, while iShares S&P Global Water charges a total expense ratio of 0.65%. Compare this to the iShares FTSE 250 ETF, where the TER is only 0.4%.

Euro Stoxx indices also offer thematic ETFs, tracking stocks from "supersector leaders" in the eurozone. And iShares has a range of funds tracking these indices with screens for growth, value and select dividends.

The iShares Euro Stoxx Select Dividend 30 offers exposure to the 30 highest-paying dividend eurozone stocks from the index, whereas the iShares Euro Stoxx Total Market Growth ETF invests in large-cap eurozone growth stocks. Ishares Euro Stoxx Total Market Value invests in large-cap eurozone value stocks. Compared to the Shariah ETFs, they are cheaper at 0.4% TER.

Investors looking for global dividend-paying companies can access these through one of the Global Select Dividend ETFs. The db-x DJStoxx Global Select Dividend 100 ETF follows an index of the highest-dividend paying stocks in the Americas, Europe and Asia-Pacific. As at 1 March, the db X-trackers DJStoxx Global Select Dividend 100 ETF was up 7% year-on-year.

Faced with this huge range of different investments, potential investors have yet to latch on to thematic ETFs.

Jason Witcombe, chartered financial planner at Evolve Financial Planning, doesn't think they're popular, and the increasing number of launches is just because providers think there is more demand. It's become "trendy" to invest in something that catches consumer sentiment. "An anti-bankers' bonuses ETF wouldn't surprise me," he says.

However, Justin Modray, founder of Candid Money, thinks they can offer a cost-effective route for investors wanting something a little different from the norm, or exposure to specific sectors. But, he stresses that "in very specialist sectors good active managers generally stand a better chance of beating the index".

Looking at the different themes, Modray likes water. "If you believe that water will become an increasingly scarce commodity, then ETF Securities S-Network Global Water looks appealing. The index comprises around 60 global companies engaged in water infrastructure and technology development with a TER of 0.65%. I wouldn't expect a smooth ride, but investing in this area could prove lucrative long term."

Shaw isn't quite as keen on environmental and water ETFs, however. "The water indices have been recently constructed, so I've got no conviction that it will do well. The liquidity isn't there and it's a very small-cap market. They're not suitable for moderate or cautious investors," she says.

Infrastructure can provide a hedge against high inflation, and these themed ETFs could be worth considering.

Modray expands: "Investors wanting more general exposure to the growth in global infrastructure might consider the iShares FTSE/Macquarie Global Infrastructure 100 ETF. This has a high bias towards global utilities providers which, in addition to potential long-term growth, should mean healthy dividends along the way – as utilities companies tend to be cash rich. Dividends are currently around 3% and the fund has a TER of 0.65% a year."

Shaw also believes infrastructure is a "great story" and a long-term theme, although she thinks the sector is more suitable for aggressive investors.

While these more esoteric ETFs are seen as trendy investments, Shaw warns against the risk of overlapping. "Thematic ETFs are very specific and there might be some sector overlap. It's easy to get carried away if you haven't got a hold on what you own. If you pick a thematic ETF you might find you've got global exposure to that sector anyway in your main portfolio."

Witcombe adds a final warning that investors would do well to remember: thematic ETFs can be very volatile. "These funds are latching onto consumer trends and sentiments," he says.

"Some of these themes are pulling at people's heartstrings and beliefs. They're trying to play on what people have a hunch in. But a lot of these funds are very small. You have to question them – you shouldn't be taking a very big bet in a very small market segment."

This article was taken from the May 2011 issue of Money Observer.