A thematic change

Funds are pouring into the thematic exchange traded fund (ETF) sector on the Australian Securities Exchange (ASX) and the acceleration of flows will push thematic funds under management (FUM) to $10 billion by the year’s end. Globally, we have seen an explosion in thematic ETFs being offered to retail investors as they demand more sophisticated and targeted investment strategies.

Thematic ETFs offer investment strategies that capitalise on enduring economic trends and shifts in consumer markets, society, and the environment over time. ETFs based on particular themes differ from traditional market capitalisation ETFs as they track specially designed indices that focus on a particular segment of the market rather than the overall stock market. 

The growth of thematic ETFs is the next chapter for the ETF market, which is underpinned by sustainable long-term economic trends. Over the six months to 31 May, 2021, FUM in thematic ETFs grew by 29.3% to $4.4 billion, while FUM in environmental, social and governance (ESG) ETFs jumped 33.7% to $3.72 billion. That growth easily exceeded growth in FUM of ASX-listed market capitalisation ETFs which grew by 15.8% to $67.8 billion.

Examples include clean energy, gaming and technology sectors and these themes are likely to endure over the long term rather than simply be short-term fads. Our Video Gaming and eSports ETF has been the fastest-growing ETF since we launched in 2013, demonstrating the high level of investor interest in these types of products. 
Other thematic ETFs which have taken off in the US include diversity ETFs, capturing themes such as gender diversity and racial equality. 

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PLAY TIME FOR GAMERS

The explosion of gaming before and during the COVID-19 pandemic has created significant investment opportunities in global gaming companies such as Tencent, Nintendo, Activision Blizzard, which have been growing as a group at a faster rate than the US tech giants. Video game engagement is breaking records across a variety of metrics. 

Research house Newzoo forecasts that 2021’s global games market will generate revenues of $175.8 billion. By the end of the year, there will be 2.9 billion players worldwide. Positive secular trends are driving the long-term growth of gaming and esports. We are seeing increasing number of gamers and time spent gaming. This will continue driving industry growth over the long term.

Last year’s release of the PlayStation 5 was long awaited and Xbox Series X|S sealed a year of record-breaking growth in 2020. Newzoo estimates that the games market generated $177.8 billion in 2020, up 23.1% year on year, the highest growth for the games market since Newzoo began tracking revenues in 2012.

The sector’s long-term structural growth story is also supported by macro trends such as demographic shifts. Contrary to the common perception that video game playing is dominated by young people, the average gamer is between 28 and 32 years of age. They grew up playing video games and continue to do so. They are often well-educated, earn more than the average consumer, and spend their money on video games and related activities. These demographics are replicated across the world.

In terms of how and where we game, the mobile or smartphone segment is the biggest, followed by the consoles. But with advancements in 5G and internet technologies – currently being rolled out in Australia and globally – this could accelerate the growth of mobile gaming as it will allow more sophisticated games to be played on handheld devices. Another supportive trend is the change in consumer preferences, with consumers increasingly going for interactive, not just passive, entertainment. Mixing social media and gaming allows them to bring their friends into the interactive online world.

The industry was already enjoying a steady growth trajectory before the pandemic accelerated the trend last year. Restrictions that have kept many at home and shut down other forms of entertainment have resulted in a bumper year for the sector. Morgan Stanley’s recent research showed that the US game industry, for example, may have pulled forward four years of video game user growth to 2020 as player bases, time spent and in-game revenue soared (Chart 1).

Esports too is a growing trend. According to 'Newzoo’s Global Esports and Live Streaming Market Report‘, global esports revenues will grow to $1,084 million in 2021, a year-on-year growth of 14.5%, up from $947.1 million in 2020. Like gaming, esports too has been propelled by internet technologies and expanding bandwidth; esports is now so popular that spectator numbers exceed that of many professional sports.  

Outside of lounge rooms and on stock exchanges, the sector offers returns which outstrip those on technology. Based on back-testing, ESPO’s index (the MVIS Global Video Gaming and eSports Index), adjusted for ESPO’s management cost of 0.55% p.a., has outpaced the tech-heavy NASDAQ 100 index over the seven-year period since 2014 to 31 March, 2021, with around double the returns. 

Importantly, the gaming and esports investment opportunity also presents diversification away from the FAANGM mega-cap tech giants, Facebook, Amazon, Apple, Netflix, Google owner, Alphabet and Microsoft. 

CLEANING UP POWER

Another huge structural growth theme is clean energy and also a recent focus for investors in the wake of the US re-committing to the Paris Agreement. The Paris climate agreement is driving demand for green, renewable energy across the globe away from fossil fuels. This is a significant long-term trend offering huge investment potential. 

The US Energy Information Administration (EIA) forecasts that power generation coming from renewable sources, such as wind, solar, hydro, and geothermal, should provide almost half of the world’s electricity generation by 2050. This move to clean energy is being driven by governments adopting renewable energy policies to meet the Paris agreement. 

Global temperatures are increasing due to human activities that produce GHG emissions, made up predominantly of carbon dioxide (81%), methane (10%), nitrous oxide (7%) and fluorinated gases (3%) recorded in 2018. 2020 tied for the hottest year on record, matching 2016. Continuing the planet’s long-term warming trend, the year’s globally averaged temperature was 1.02 degrees Celsius warmer than the baseline 1951-1980 mean, according to scientists at NASA’s Goddard Institute for Space Studies (GISS). 

The carbon footprint is therefore an important consideration when evaluating investment products which claim to help combat climate change. In addition, investors must ask:

Does the vehicle invest in companies which contribute to reducing industrial carbon emissions? Those companies can be powerful investment opportunities. In the last 12 months alone (to 31 May, 2021), the S&P Global Clean Energy Select Index had gained 66.8% and is up 35.0% per annum over three years.

The S&P Global Clean Energy Select Index aims to represent the full clean energy ecosystem by including companies from both the clean energy production and the clean energy technology and equipment sides in the various renewable energy segments across the globe. That includes solar and wind energy production, hydro electricity production, biofuel, ethanol and alcohol fuel production, and related technologies and equipment production. 

HOPE LIES IN HEALTHCARE 

The final sector where we are seeing significant investment opportunities is global healthcare. Even before COVID-19, healthcare spending was rising strongly across nations given ageing demographics and emerging nations’ healthcare systems catching up to developed nations’. Investors are likely to reap the benefits of a long-term expansion in healthcare investment.

Global healthcare expenditure accounted for around 10% of the world’s gross domestic product (GDP), or US$11 trillion (14.9 trillion), as at 2018. With global GDP projected to grow to US$137 trillion by 2030, and healthcare expenditures projected to remain at 10% of GDP, this translates into US$14 trillion in healthcare spending per year by the end of this decade. The combination of global population growth and the prevalence of chronic diseases will contribute strong demand for healthcare. 

The COVID-19 pandemic has also highlighted the importance of global healthcare and pharmaceutical products such as vaccines. Australian investors are generally underweight healthcare stocks relative to international benchmarks. The local sector is relatively small and is dominated by CSL, therefore an allocation to global healthcare is an important diversifier. 

In terms of long-term returns, the performance of global healthcare have been very attractive. Taking a market capitalisation approach to global healthcare leaves investors with a long tail and potential concentration risks. Active managers make bets on who they think might be tomorrow’s winners based on complex and risky factors such as drug trials, novel science and winning regulatory approvals. 

A smart beta, or rules-based approach, that targets companies that consistently deliver growth has the potential to deliver greater rewards to investors over the longer term.  

With ASX-listed thematic ETFs, which are accessible, liquid and low cost, investors can position their portfolios to take advantage of these important economic and secular trends that are shaping the future. 

Arian Neiron is chief executive of VanEck.