Why thematic investing is hot

By Larissa Fernand |  08-08-19 | 
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Larissa Fernand is Website Editor for Morningstar.in. She would like to hear from you and welcomes your feedback.

Thematic or flavour-of-the-moment ETFs have been grabbing headlines globally.

There are Robotics and Automation ETFs providing investors access to rapidly evolving robotics, automation and AI companies. Millennial Thematic ETFs that seek to invest in companies that have a high likelihood of benefiting from the spending power and preferences of millennials. Cannabis ETFs, which need no explaining. Sustainable Investing ETFs, which look at ESG parameters. Emerging Market ETFs. You get the drift.

In India, the ETFs are rather undistinguished and conventional. You can get a glimpse of them here.  But if this is where the market is headed globally, we can be sure to head in this direction.

My colleague in Australia, Emma Rapaport, recently joked that there should be an ETF offering exposure to the products Kim Kardashian spruiks on her Instagram. She spoke to other experts in Morningstar and penned down some extremely interesting insights, which have been reproduced below.

Thematic ETFs appeal to investors because they are relatively easy to understand, particularly when you consider the amount of jargon in financial products. Investing themes tend to tap into powerful narratives that are often well-known to investors, such as aging populations or the shift to a digital economy, making them easy to relate to.

- Morningstar research analysts, Kenneth Lamont and Hortense Bioy

Stories are really powerful to us because they're easy to remember. They're small and easy for our minds to understand. A story is a self-contained thing that has meaning in our lives. Our brains love self-contained things that have meaning. Generally, in a story, we're able to make an emotional connection to what's happening. Emotions solidify memories and add salience to an experience. So, if something is emotionally charged, we're more likely to remember it and place higher importance on it.

- Morningstar behavioural economist, Sarah Newcomb

Thematic ETFs may be relatively new on the scene, but their use of compelling stories about the changes investors see taking place around them is a strategy that has been used to lure investors for centuries.

The South Sea Company, a British joint-stock company founded in 1711, used a well-spun narrative about its ability to exploit its exclusive right to hold, silver and other exotic commodities in South America to entice new investment. Investors piled in, but the company's ability to capitalise on these rights faced big hurdles, and its underlying businesses and ultimately proved unstainable.

Narratives like those used by the directors relied on simplicity, plausibility, and dramatic emotional connection to exert a powerful pull on the public, causing them to make decisions based on emotion and reaction rather than logic and reflection. Plausibility is part of what makes a well-crafted narrative compelling and credible, even if the circumstances aren't factually true.

Thematic ETFs are modern-day investment strategies that rely on simple, catchy stories to attract investors.

 - Morningstar manager research analyst, Daniel Sotiroff 

It's not just inherent cognitive biases that have allowed this industry to flourish. Other forces such as cost and ease of access are also at work. The ETF industry has levelled the playing field for retail investors by bringing down costs and expanding access to managed investment trusts. These same factors have simultaneously lowered barriers to entry for asset managers, allowing new players to enter the industry at far lower costs relative to launching an actively managed unlisted funds. Given the relatively low hurdles facing prospective entrants and the large potential rewards, it's no surprise that there has been a gold rush in the ETF space.

- Morningstar director of passive funds research, Ben Johnson

 You can access the original post here.

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