Here for the long run

Could investment companies be a better option than thematic ETFs?

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The investment industry likes nothing more than a new “big thing”. Seemingly innovative ideas provide an opportunity to launch new products and grow funds under management. You don’t even have to demonstrate a track record of success, given that you’re pitching a novel concept.

One of the latest such fads is the thematic exchange traded fund (ETF). These are ETFs in the conventional sense, in that they replicate the performance of a specific index. But unlike an ETF that tracks the FTSE 100, for example, they are pegged to bespoke indices designed to give exposure to a hot investment theme – clean energy, say, or digital transformation.

Thematic ETFs have attracted huge amounts of money this year - €32.4bn in the second quarter of the year alone according to Morningstar. They play into investors’ liking of passive funds more generally, but also attract interest because they are focused on of-the-moment investment ideas.

However, in my view, advisers and investors joining the thematic ETF party may be in for some nasty surprises. One issue is that these aren’t really passive funds at all; there is a significant element of active management involved, at least at the outset, because the index has to be built for the job. Also, the themes that these funds focus on are fast-moving, potentially volatile and often highly specialist; this cries out for active management delivered by sector experts on an ongoing basis.

Given those fears, a recent Investors Chronicle article made interesting reading. It suggested investment companies might be a better option for investors seeking exposure to some of the areas where thematic ETFs are now active. It pointed to the Seraphim Space Investment Trust launch, for example, which is taking on several ETFs offering exposure to the space sector. The HydrogenOne Capital Growth fund is another new investment company in an area where ETFs have been picking up assets.

What you get with these investment companies is managers with sector expertise and an active approach that isn’t bound up in the confines of an index. Active management doesn’t always outperform, of course, but in niche areas poorly understood by the broader market, active managers are more likely to deliver.

In truth, this is what investment company managers have been doing for many years. Space and hydrogen are just two more examples of investment opportunities where investment companies are providing a collective fund vehicle structure that broadens access. You might point to investment specialisms ranging from healthcare to infrastructure as other examples. Indeed, over more than a century, investment companies have consistently been trailblazers when it comes to giving investors access to emerging themes.

In that sense, the idea that investment companies might be an alternative way to pursue thematic investment opportunities is a slightly odd one. Investment companies are the original thematic funds – and managers continue to scour the market for new themes that might prove to be of interest.

It is a reminder that fund or product structure should be a secondary issue for anyone considering a new investment opportunity. Thematic ETFs may be the hot new thing, but they’re playing in a space where investment companies have been active for years.