Why advisors should take a measured approach to thematic investing

Mackenzie Investments head of ETFs says it's hard not to get excited by innovation but it's also wise to factor in inherent risks

Why advisors should take a measured approach to thematic investing

As the head of ETFs at Mackenzie Investments and chair of the Canadian ETF Association, Michael Cooke has a front-row seat to the workings of the ETF ecosystem. He’s watched with interest the rise of thematic investing, which has allowed advisors to finely slice and dice various segments of the financial markets.   

While some advisors have particular views on a sector or asset class – and are willing to do their own research – many don’t want to worry about individual security selection when they can have it bundled together in a relatively cost-effective and liquid vehicle.   

However, Cooke warns advisors to be careful about how they use thematic ETFs. He says it’s vital to have a foundational asset allocation that serves as the core of the portfolio based on the client’s tolerance for risk, timeframe for investment and return or income objectives. Around that, advisors can introduce thematic, satellite investments that offer growth potential and alpha generation through innovation.  

“But there’s also some risk inherent because a lot of these sectors are new,” he says. “They're composed of a disparate group of companies, some of which are going to survive, some of which are profitable, some of which are not. And because they are disruptive technologies, they're going to also be prone to volatility – and sometimes volatility is the enemy of successful and prudent investment. Make sure you're measured in how you allocate to these strategies, and don't get carried away in your enthusiasm by the impressive headlines and performance that some of these strategies can put up because you can give it back.”  

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That said, Cooke says it’s hard not to be excited by the innovation taking place right now. He compares the emergence of blockchain as being to Bitcoin what the internet was to email. Blockchain continues to disrupt and democratize the global economy, although it remains volatile. Blockchain’s most popular byproduct, cryptocurrency, is at the forefront of thematic ETFs – just this year, Purpose Investments launched the world’s first Bitcoin ETF, Horizons ETFs began offering an inverse Bitcoin ETF, and Evolve ETFs recently launched Canada’s first multi-crypto ETF.  

“Cryptocurrency ETFs have drawn a good cross-section of different investor segments,” Cooke says. “Interestingly, some are drawing institutional investors, both domestic and offshore financial advisors, and, of course, DIY investors. All these investors are seeing the benefits and versatility of the ETF structure.”  

Beyond “flashy” ETFs like Bitcoin and blockchain, Cooke sees innovation “even in something as seemingly vanilla as index design,” which he believes has incrementally improved the investor experience. The ability of ETFs to incorporate emergent asset classes, such as those focused on China’s massive economy, has also caught his eye.   

“It's fair to say that almost all institutional and retail investors are underweight in their exposure to the massive economic engine that is the Chinese economy,” Cooke says. “A lot of intelligent people believe there are emerging two poles of economic growth globally, one that is the US and one that is led by China. It’s prudent for investors to think about that.   

“Yes, it does come with a little bit more risk and other considerations that have to be weighed into the mix, but it does represent innovation as a type of investment that has been previously very difficult for investors to access. That’s another hallmark of the ETF industry – delivering inaccessible exposures to investors of all types.”  

Sustainable investing is an area that’s been pushed to the front of a lot of investors’ minds as the COVID-19 pandemic has exposed the fragility of our world. While clean energy innovation has been around for a while, its importance to society has probably never been greater, Cooke says, and a fast-growing subset of the responsible investment landscape is sustainable bonds. Within that category are green bonds, which are typically designed to finance various climate-related or environmental projects, and sustainability-linked bonds, which are related to companies that score well on proprietary ESG metrics. Mackenzie launched a global sustainable bond ETF in September that has already garnered interest from institutional investors.   

Cooke believes sustainable bonds are an emerging space within the fixed income market, and another example of how innovation can take different forms.  

“We continue to look at the spectrum of innovation and where we might find opportunities, but we're always focused on what we think are our sustainable, enduring investment themes,” he says. “We're not just trying to latch onto the flavour of the day, which might be nice in the short term in terms of gathering excitement and assets, but we want ideas that are durable and can have a rightful place in investor portfolios.  

“There are obviously indirect ways to play some of these innovation themes through more core portfolios. We’re well down the path of looking at how we might add some of these innovative ideas to our shelf, but we want to do so prudently and to make sure they have some staying power.”