Thinking green (investments)? Why it rarely pays to buy niche ‘thematic’ ETFs

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Few investment sectors were hotter last year than electric vehicles, motored by growth in Tesla’s share price.

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Fueled by ideas that transportation is on the verge of structural change, investors sought out the next Tesla Hydrogen fuel cell producers were one of the beneficiaries in investors’ hunt for another alternative energy emerging technology.

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Small companies in the hydrogen-industry space, such as Plug Power Ballard Power Systems and Bloom Energy saw valuations skyrocket in 2020 and early 2021.

Exchange traded fund issuers followed the trend, launching two separate ETFs on this niche theme, Defiance Next Gen H2 ETF and Direxion Hydrogen ETF in March.

But those ETFs were launched just as demand for growth stocks slumped and as investors started to exit the clean-energy space in the first quarter after 2020’s big run. The hydrogen darlings now sit with valuations down 50% or more.

Shiny new object

Environmental, social and governance (ESG) investors who bought up hydrogen industry stocks last year are now learning a hard lesson, and it’s a reminder that the bright, shiny object can quickly dull. While many analysts are positive on the long-term outlook for electric vehicles and the clean-energy industry, it can take time for investments in a long-term trend to pay off, especially if valuations are high.

Brett Manning, senior market analyst at Briefing.com, says it’s often the case that, once an ETF for a popular theme is created, the stocks that are tracked or selected as part of the portfolio have gone from attractive to expensive. That increases the risk that those rich stocks will give up gains.

A prime example of hyped-up investments that haven’t recouped their initial prices are cannabis ETFs, Manning says. An example is ETFMG Alternative Harvest The first ETF of its kind, Alternative Harvest debuted in 2015, and its five-year return is down 1.51% according to Morningstar data.

Long-suffering investors

Determining whether an investing theme has staying power takes time, and early investors may suffer losses for a long time. That was the case for clean energy.

Several alternative-energy ETFs launched in the early 2000s in response to crude-oil prices trading well over $100 a barrel. Many closed. The VanEck Vectors Solar Energy ETF debuted in 2008 and ceased trading in 2017.

Only recently have clean-energy ETFs become profitable as the fundamentals of the industry changed, Manning says, pointing to 2020’s popular Invesco Solar ETF as an example. It launched in 2008, and looking at yearly total return for the ETF using Morningstar data, the fund lost money almost annually from 2011 to 2019. In 2019, it rebounded, jumping 66.53%, and the following year it soared 234%. Those mega rallies ended up putting annualized returns in the positive category — the fund now shows a 10-year return of 2.99%.  

Even a diversified global clean-energy ETF such as the 16-year-old Invesco WilderHill Clean Energy ETF suffered losses for much of its existence. Its 15-year return is down 0.8%.

WIZE, WSKY and SLIM

Thematic investing really took off in 2016, with fund issuers using colorful tickers to help them stand out in the crowd. But many closed.

One of the shortest-lived funds was the CrowdInvest Wisdom ETF, which had the ticker WIZE. It launched in April 2016 and closed five months later. It was a smart-beta ETF whose index was composed of U.S.-listed equities weighted by sentiment built by an independent, diverse crowd.

An alcohol-beverage themed ETF with the ticker WSKY, Spirited Funds/ETFMG Whiskey & Spirits ETF, shut with less than two years under its belt.

The Obesity ETF, whose ticker was SLIM, was a health-care-focused ETF comprising companies that provide treatment and care for obesity and related diseases. It closed in 2020 after four years.

Thematic investing is seeing a resurgence, and a lot of it focuses on emerging technology trends.

Amy Arnott, portfolio strategist at Morningstar, wrote in a recent post about the pitfalls of thematic investments. She notes over the past 10 years, thematic fund shareholders were subject to lower returns and higher volatility versus the Morningstar US Market Index, and that figure includes funds still around today. About 30% of the thematic funds launched in the past 30 years were closed, she adds.

Infrastructure investments

Manning says investors may be drawn to niche products that target the latest trend, infrastructure investing, seeking out funds that may benefit from President Biden’s infrastructure plan. Copper prices are up 20% this year, in part, based on expectations the industrial base metal will be used in host of infrastructure projects. Copper’s gains are reflected in the United States Copper Index Fund one of two copper exchange-traded products. It’s up 17% this year.

Rather than targeting copper, Manning suggests investors would be better served by a diversified ETF. Renewable energy could serve that purpose as it cools off following last year’s sizzling gains.

‘Buy the dartboard’

It’s an ESG theme, but compared to a dozen years ago, the industry is undergoing sustainable structural change — falling costs and greater adoption among them. A diversified renewable energy ETF might be a better pick over an unproven niche play such as hydrogen.

“If you’re diversified in the direction of something that’s going be in line with a multi-trillion-dollar, long term-catalyst, why try to hit the exact bull’s eye and score no points? Buy the whole dartboard,” he says.

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