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Data technology walkway

Thematic investing flourishes in Asia


August 2022

Global megatrends such as the rise of sustainable energy, electric vehicles and biotechnology are driving greater interest in thematic investing across Asia.

Will Tu, ICE’s Director of index business development in the Asia Pacific, says eleven new thematic, climate and ESG exchange traded funds tracking ICE indices were launched in 2021 alone, rapidly accumulating more than $1.72 billion in assets under management.

These newly launched funds were part of a near quadrupling to $17.1 billion in assets in Asia-listed ETFs tracking ICE indices since 2018.

Investors in Asia have access to a wide range of thematic ETFs covering themes as diverse as 5G telecommunications, e-commerce and logistics, cloud computing and AI, computer gaming —even the future spending habits of the Chinese consumer.

“Thematic investing will drive the next evolution of ETFs,” says Tu, speaking from ICE’s Hong Kong offices.

“The first generation of ETFs were the broad market products — examples include the S&P 500®, NASDAQ-100®, Hang Seng or FTSE TWSE Taiwan 50 Index. The second stage included regional Asia-Pacific ETFs. Then came sectors like technology or finance. Now, thematic ETFs are becoming more and more popular.”

Tu says there are two underlying drivers of the fast-growing sector.

First, ETF providers are competing to differentiate themselves from traditional index funds by providing investors with new ways to invest. And investors themselves are searching out new ways to gain exposure to the major trends driving future economic growth.

Tu recalls the ETF industry flirting with so-called ‘smart beta’ products that aim to select constituents based on factors like value, momentum or growth.

But he says these products never really took off in Asia as they were difficult to understand.

“What is value? What’s momentum? Remember that ETFs are exchange-listed, and their main purpose in the region is to serve the retail investment community. This resulted in a pivot towards easier-to-explain thematic investing.

“Every day you see headlines in the news regarding electric vehicles, and you see friends driving EVs and you think ‘this is a good idea, what kind of tool can I use to invest in this booming industry?’

“The answer is a thematic ETF. An asset manager can create an electric vehicle ETF which covers the entire supply chain of EVs, allowing investors to obtain exposure to the growth of that industry and theme.

“It’s very easy to communicate that concept with investors.”

But how does thematic investing work? And where does it fit into a portfolio?

Tu says that fundamentally, ETF providers aim to hold a range of companies exposed to a given theme to provide diversified exposure to the growth generated by that trend.

“As an example, I may be positive on the development of electric vehicles, but I am not an expert on lithium batteries or how battery technology is going to evolve.

“When we create a new index for that theme, we think about how to classify the companies that focus on this type of new technology development.

“It’s very fundamentals driven. We look at granular data such as revenue breakdowns to ensure the index constituents generate tangible revenues from the theme that we define.”

This makes the index a very efficient way for investors to get access to an investment trend without needing to fully understand the supply chain of the industry or make a bet on individual companies.

“It’s very similar to active investing without having to pick individual stocks,” says Tu.

This connection with active investing explains why thematic ETFs are growing so quickly in Asia, says Tu.

“Asian investors are traditionally very active in equities, especially in Hong Kong, Taiwan and Korea where they have strong views on which companies will outperform and underperform.”

Tu says that when choosing a thematic ETF, investors should look “under the hood” at which stocks are contained in its underlying benchmark index and also how the index is constructed.

Regulators require ETF providers to disclose the underlying index methodology which allows investors to check whether the index methodology and constituents can deliver on the theme.

“Do you want to invest in a broad-based theme or do you want to get very narrow and specific about what you’re trying to target?

“Either way, make sure you understand how the ETF provider defines the theme and how the underlying index methodology is compiled.”

Tu says the way an index is constructed can have important impacts on the eventual investment in the ETF.

“If the ETF issuer has a requirement that companies in the index must be profitable, this could screen out start-ups.

“It's a trade-off. If I'm focusing on a more mature theme, then I would probably prefer the ETF to include well-established companies generating positive earnings.”

“But if the ETF is focused on a theme in its early stages, like blockchain or the metaverse, investors may prefer to focus on pre-profit companies showing growth and revenue,” he says.

So, what’s the future of thematic ETFs?

Tu says it’s an investment option that looks to be getting more popular.

“If you look at the assets under management of these ETFs, it confirms they have been very well received by investors.”

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  • Thematic ETF providers aim to hold a range of companies across sectors to provide diversified exposure to the growth generated by a given theme
  • Thematic investing is essentially active investing without having to pick individual stocks. Investors in Asia have traditionally been very active in equities, which explains why thematic ETFs are growing so quickly in Asia.
  • Investors should understand how an ETF provider defines a given theme and how the underlying index methodology is compiled - for example, if a theme in its early stages like blockchain or the metaverse is best be captured by pre-profit companies, any screening process should not exclude these firms.