Thematic ETFs promise a way for advisors to help investors tap into specific growth trends and target exposure to sectors or themes that are aimed to produce specific outcomes for clients. But, according to Adam Patti, CEO of VistaShares, thematic ETFs fall short of expectations by becoming too similar to one another when the underlying investments are compared, creating difficulties for advisors looking to diversify client portfolios effectively.
Patti believes that a strategic refresh is needed to align thematic ETFs with their purpose so that they better match the intended themes and outcomes, mitigating concentration risks while capitalizing on emerging opportunities.
We caught up with Patti to discuss the problem with thematic ETFs today, the risks it poses for advisors’ clients and steps to recast thematic ETFs to overcome these.
WSR: What underlying reality has emerged in recent years with thematic ETFs?
Patti: At its core, the idea behind thematic ETFs is a good one: identify a compelling theme that may provide investors with growth opportunities and package it in such a way that the theme can be added to a portfolio in a single-ticker solution. However, what has happened over the years is that while the number of thematic funds has exploded, the underlying portfolios too often end up looking markedly similar, regardless of whether the themes bear any relation to one another. What’s been great for marketing has not delivered for investors.
What’s been great for marketing has not delivered for investors.
WSR: What risks does this underlying reality create for advisors and their clients?
Patti: Often, those recurring names come from Magnificent 7 stocks that have driven much of the market’s gains the past several years. Being concentrated in the Mag 7 paid off in the short-term but, as their respective values have grown, so too have their weights in numerous thematic portfolios, meaning investors who were likely already overexposed to the biggest names in technology have only gotten more so.
Thematic ETFs were supposed to provide a simple way to diversify portfolios. But they have become a key source of overconcentration and investors who have not checked “under the hood” of their thematic holdings may be in for a surprise when one or two big name stocks take a turn and have an outsized negative impact on their overall portfolios.
Investors who have not checked “under the hood” of their thematic holdings may be in for a surprise.
WSR: What should be done to resolve the problem?
Patti: The solution isn’t to abandon thematic ETFs. Far from it, actually. Instead, a shift is required in the way thematic ETFs are developed, managed and explained. The best way to approach this is make sure that any thematic vehicle is being overseen by an expert team that has actual, hands-on experience in the theme a fund is supposed to be capturing.
That type of practical viewpoint and the deep level of subject matter expertise that comes with it should allow for the construction of portfolios that aren’t just “large cap tech” under a variety of different names, but rather a process that identifies those emerging companies or those key providers of services and materials, the “picks and shovels” of a given theme, which are essential to continued growth and innovation, and make sure they are well represented in a thematic ETF’s underlying portfolio.
WSR: What are some approaches VistaShares is taking to address these issues?
Patti: We’ve chosen to tackle these problems head-on. The VistaShares Artificial Intelligence Supercycle ETF (ticker: AIS) is an example of this. Instead of building another AI-focused ETF that focuses on the typical mega-cap “brand name” companies that most investors already own, we’ve leaned on the experience of our leadership and advisory teams to dig into the global AI infrastructure supply chain, map out the bill of materials required to build this infrastructure, and then identify the companies that are driving innovation throughout the supply chain.
While the core of our portfolio is a patent-pending rules-based process centered on our bill of materials research, our Investment Committee is actively engaged to oversee the portfolio and provide that risk management overlay.
Jeff Berman, Contributing Editor and Reporter at Wealth Solutions Report, can be reached at jeff.berman@wealthsolutionsreport.com.
