On the latest episode of ETF Prime, VettaFi’s associate director of research Roxanna Islam joined host Nate Geraci to look under the hood of electric vehicle ETFs and offer perspective on thematic ETFs overall. Innovator ETFs’ John Southard explained Defined Outcome ETFs, which are experiencing a meaningful uptick in investor interest. To round out the show, Touchstone Investments’ Rich Koerner discussed the firm’s recent ETF entrance and “distinctly active” approach.
Electric Vehicles and Other Themes
When investigating thematic ETFs, it can be challenging to separate the hype around a particular space from the reality of that space. Geraci noted that “Investors may hear about certain companies within a thematic category where there is a lot of media buzz and hype, and investors get excited – they want to own these companies – but then when you actually look at the reality of the situation in terms of what these thematic ETFs hold, the buzzy companies aren’t always there.”
Islam observed that thematic ETF interest shot up during 2020, a completely different environment from what we’re in right now. “Broader equity markets were doing well,” she said, continuing, “crypto became really popular. Investors were just becoming much more confident. They were attracted to these individual stocks in the media or on Reddit, returning these massive amounts in a short amount of time.” She thinks many investors were looking for the next Tesla or Apple, but a smarter play in thematic investing isn’t to aim for an instant winner but to play a long-term shift in behavior, technology, or regulations.
Electric vehicles are a crowded space in the ETF world. Islam sees two interesting sides to EVs; on the one hand, she notes that there are exciting start-ups building new EV products, trying to carve a slice away from Tesla’s 75% market share. On the other hand, legacy companies like Ford are slowly shifting production away from standard combustion to EVs. “I think investors and consumers are more excited about the ‘new entrant’ story first. Not only are these products flashy and high tech, but the stocks are really exciting,” she said, noting that a number of these new entrants haven’t even hit production yet and must contend with supply chains and other challenges. Islam said, “when you look at these ETFs, most are based on that rules-based index, and they actually end up hedging their exposure to some of those smaller, more volatile stocks.”
This creates a disconnect between what investors might think they are getting and what is actually inside popular EV ETFs such as the First Trust S-Network Future Vehicles & Technology ETF (CARZ ), the iShares Self-driving EV & Tech ETF (IDRV ), and the Global X Autonomous & Electric Vehicles ETF (DRIV ).
Geraci asked Islam if battery technology ETFs such as the Global X Lithium & Battery Tech ETF (LIT ) or the Amplify Lithium & Battery Technology ETF (BATT ) could be decent proxies for the electric vehicle theme. “I think somewhat,” Islam responded, noting that there is a lot of crossover between holdings and have correlations between .7 and .8. “But there are some key differences,” Islam said, pointing out that battery ETFs tend to have more exposure to China. Because they tend to cross into other sectors, such as commodities, battery ETFs have sometimes performed better than EV ETFs. Like any disruptive tech stocks, these funds have had some challenges this year. But Islam sees plenty of reasons for the EV theme to potentially thrive in the future, given coming regulations. “I think the EV space is as concrete as you can get when it comes to a thematic idea.” She believes electric vehicles are happening, it’s just a matter of capturing how it happens. She said, “That’s the beauty of an ETF, it can diversify away that single-stock risk that you get when you are trying to find the next Tesla out there.”
Islam also thinks that many people don’t fully understand space. First off, fully autonomous vehicles are still in the works and are not truly finished products. She also noted that “there are also electric vehicles beyond cars and trucks. There are electric aircraft and passenger drones, and several public companies are already in that space. You have to anticipate all this.”
Pivoting to a more general look at thematics, Islam thinks they should be a smaller portion of the portfolio as a supplement to core holdings. “A lot of these are higher growth, higher risk/reward investments.”
Moving to crypto, Roxanna noted the similarities that space has to the EV space. “It is important to remember this sector is also very new. Bitcoin itself has been around less than 15 years.” She sees crypto as historically a sentiment-based space that is now seeing a broader shift as regulations are in the pipeline. “I don’t think it has run its course; there’s a lot of room for it to run,” she said, cautioning investors to do their due diligence. “You have to make sure what you are investing in lines up with your expectations.”
Buffered Outcomes Amid a Battered Market
John Southard joined Nate to talk about Innovator’s buffered outcome products. Despite launching its first product in August 2018, Innovator boasts 90 products with roughly $9 billion AUM. This year Innovator has seen $3.5 billion in new money. The company recently launched the Innovator Hedged TSLA Strategy ETF (TSLH ).
Buffered outcome products sacrifice some upside to mitigate downside risk. The topsy-turvy markets have helped drive some of Innovator’s recent success. Southard said, “you hate to capitalize on scary times, but you got to remember when we first launched these, August of 2018, it was a very different time. We were on a 10-year bull market, and the thought of a defensive type product – at that time – fell on a lot of deaf ears.”
Discussing Innovator’s founding, Southard talked through his crash course on derivatives and said, “that’s what we set out to do – to bring a lot of the products offered by insurance companies and banks and put them in the ETF wrapper.” He continued, “the more I’ve done ETFs, the more I’ve appreciated the chassis or vehicle itself.”
The defined outcome ETFs are Innovator’s “bread and butter,” according to Geraci. By providing risk management through giving up some of the upsides through a cap in exchange for downside protection, defined outcome products are especially important during times of market turmoil for investors who wish to stay in the market but need to mitigate risk.
“I think investors like the clarity of it all,” Southard said, explaining that “It is a way for you to tailor returns to meet your investor risk and what you want to achieve in your portfolio.”
Southard and Geraci also discussed Innovator’s structured hedge product for Tesla, TSLH. “This one is unique in that its actually a floor product,” Southard said, noting that the floor means that the product can’t go down by more than 10%, making it a good choice for advisors who wish to be invested in Tesla but don’t think it will achieve the massive growth it has in the past. “It’s basically putting guardrails on [Tesla.].”
Distinctly Active Management
Touchstone entered the ETF game in July with Touchstone Strategic Income Opportunities ETF (SIO ). They quickly followed up with three additional ETFs, with nearly $200 million in AUM, despite being a new face in the ETF space.
Geraci’s final guest, senior Touchstones’ ETF sales specialist Richard Koerner, said, “Our model is, we think, unique – we work exclusively with institutional sub advisors.” Though new to ETFs, Touchstone has been around since 1994 and has many mutual funds. “We’re excited to bring our unique brand – ‘distinctively active’ – to the ETF wrapper.”
Koerner thinks that it is challenging to be a broad-based asset manager. For example, a large cap manager uses different skills than a small cap manager. Touchstone sees utility in using best in asset class subadvisors.
Regarding their distinctively active approach, Koerner said, “our distinctively active strategies are those that we’ve found have a historical track record of generating alpha and a high active share.” Noting that many see Fixed Income as the main space for active management, Koerner said, “we think you can find excellent active managers on the equity side.” By eliminating “bloated” high AUM managers, many skilled active managers are positioned for success on the equity side of active management.
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