Thematic exchange-traded funds saw fund inflows of about $38.8 billion in the first half, compared with $7.8 billion in the first half of 2020, according to Morningstar Inc. There are now 191 such funds with a combined $164.2 billion in assets, up from 55 funds and $11.2 billion in assets five years ago.
Investors are shifting “from buying individual ‘story’ stocks to thematic ETFs to get diversification in some of the hottest growth markets in the world,” says Todd Rosenbluth, CFRA’s senior director of ETF and head of mutual-fund research.
To be sure, themed funds are riskier than ETFs that follow the broader market and can tank when enough investors start to think a trend has run its course. Cloud computing, for example, while still seen as a strong trend for the long term, has lost momentum recently as the pandemic has started to wane and fewer people are working remotely. Through June 30, ETFs based on cloud computing have seen net outflows of $600 million this year, Morningstar reports.
The Wall Street Journal asked a number of ETF experts to identify themes they believe are likely to produce strong returns for years to come. Here are five:
1. Cloud Computing
In 2020 the pandemic accelerated cloud migration for all types of enterprise applications as more people shopped online and worked remotely. Now, despite an easing of pandemic concerns in many places, demand for cloud computing continues. Many countries have cloud-based development projects in the works that should drive the market’s growth globally. Deloitte projects a 30% compound annual growth rate for the cloud sector through 2025.
First Trust Cloud Computing (SKYY) is a $5.8 billion fund with a large-cap focus on such companies as Microsoft, Oracle and Amazon.com. Though it is up 11.5% this year through June 30, it has a one-year total return of 42.5%. WisdomTree Cloud Computing Fund (WCLD), a $1.1 billion fund that tracks an index of 50 companies, is up 4.4% this year as of June 30, but it has a one-year return of 43.5%.
“Spending on cloud technology continues to accelerate,” Mr. Rosenbluth says. “We are in the beginning stages of this boom.”
Downside risk: Demand for thematic ETFs in cloud computing has waned in recent months as the effects of the pandemic recede and states are generally reopening. If employers shift technology spending to support on-site personnel, cloud companies could face less demand.
New cannabis and hemp industries are emerging in the U.S. thanks to some form of legalization in 36 states and the District of Columbia. Congress has reintroduced legislation to federally legalize marijuana for recreational and medical use throughout the country. With the Democrats controlling both houses, this has a good chance of passage. The legal cannabis market is expected to double to $41.5 billion by 2025, projects New Frontier Data.
Amplify Seymour Cannabis ETF (CNBS) is a $145 million fund that invests 80% of its assets in companies that derive 50% or more of their revenue from cannabis and hemp. It has year-to-date returns of 47.7% and one-year returns of 136.6%. Global X Cannabis ETF (POTX), a $191.5 million fund, has a year-to-date return of 40.1%, and a one-year return of 38%.
“Cannabis is one of our top themes this year as states move to legalize it for revenue,” says Jay Jacobs, senior vice president and head of research and strategy at Global X ETFs. “This is the tipping point for the cannabis industry.”
Downside risk: Cannabis companies face changing compliance issues. At the same time, mounting competition from large brands is spurring industry consolidation, which may portend volatility in the sector in the years ahead. Small-cap cannabis companies have limited resources to offset these challenges.
President Biden’s American Jobs Plan aims to create millions of jobs through infrastructure spending. While the initial plan’s $2 trillion price tag had Democrats and the GOP deadlocked, a roughly $1 trillion slimmed-down bipartisan version could have a better chance of passing.
Global X US Infrastructure Development ETF (PAVE) invests in all players in the construction supply chain, including raw-materials producers and engineering-service providers. It is up 21.4% this year and has a one-year return of 69.3%. IShares U.S. Infrastructure ETF (IFRA) also invests in construction and materials companies and in railroads and utilities. It has a one-year return of 51.8% but is up 18.4% year to date.
“Infrastructure investment is a way to stimulate the economy,” says Mr. Jacobs. This is one area of consensus between Democrats and Republicans.”
Downside risk: The bull run in these stocks could end if the infrastructure bill fails to pass in Congress.
4. Clean Technology
The Biden administration is giving priority to clean-tech investments such as renewable energy and electric vehicles. Despite a decline in clean-tech stocks in the first half, ETFs in this area have had strong one-year returns.
Invesco WilderHill Clean Energy ETF (PBW) is a $1.94 billion fund that invests in clean energy and conservation. It has a one-year return of 131% but is down more than 9% so far for 2021. Global X Lithium & Battery Tech ETF (LIT), a $3.2 billion fund, invests across a range of battery interests, from mining to battery production. It has a one-year return of 129.4%, and 17.9% year to date.
Downside risk: Clean-tech stocks have gotten swept into the technology selloff, and volatility in the sector remains high in the short term. The sector has become crowded, MSCI reports, and could fall sharply if there is an economic downturn or outbreak of stagflation.
5. AI and Robotics
Companies are increasingly using AI and robotics to alleviate supply-chain issues and boost productivity. The market is expected to grow at a compound annual rate of 20% through 2026 and reach $74 billion, according to Mordor Intelligence. It is the centerpiece of many disruptive shifts in industries from manufacturing to space exploration.
ARK Autonomous Technology & Robotics ETF (ARKQ) has a one-year return of 83.8% and a year-to-date return of 13.3%. Global X’s Robotics & AI ETF (BOTZ), a $2.6 billion fund, has garnered a one-year return of 46.6%, and year-to-date return of 5.8%.
Mr. Rosenbluth says, “Companies learned the benefits of automation during the pandemic and have sought out ways to be even more efficient.”
Downside risk: Job losses as a result of advanced AI and robotic systems in the workplace could cause serious pushback from unions as low-skill jobs get delegated to machines. High investment costs could slow adoption of the technology.
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