Personalization is the “it” service for financial advice providers: whether it is matching investments to specific outcomes, like income generation, or handling unique tax situations, or even reflecting specific ethics or interests. Direct indexing and custom separately managed accounts are starting to dominate the discussion of how to best provide this personalization, but Charles Schwab says there is another way to tailor holdings to a client.
That would be through allocations to thematic ETFs.
“Everyone should have exposure to large-cap and small-cap and international, but what you can actually do is just complement that with areas that interests of you,” said Schwab Asset Management Chief Executive Omar Aguilar at the FT’s Future of Asset Management North America conference last week. Regardless of the niche, such products can allow clients to generate greater returns, or express personal values.
“To us, those two things are what thematic does,” Aguilar said.
Omar Aguilar says thematic strategies can serve as important tools for expressing personal interests or ethics at the FT's Future of Asset Management conference.
And, Aguilar said, casting these products as a means to meet client needs for exposure to a specific trend or aspect of the economy is a much more powerful story than how they provide better or different financial returns than a traditional holdings.
This is an important frame for advisors for two reasons. One, it refines conversations with clients to understand exactly what they seek in an investment – and helps guard against the temptation of a flavor-of-the-week ETF with little long-term investment merit.
If you’re struggling to explain how thematic ETFs differ from traditional sector funds or active strategies, Aguilar suggested this: “It’s something that has fundamental economic or financial values that you want to have exposure to, and you don’t have a place to do it with the traditional investments you have today.”
For example, for exposure to something like the metaverse or electric vehicles or blockchain, investors would have to look across a number of sectors and have expertise in understanding the full ecosystem of companies involved and exactly what exposure a particular stock has to a theme. Artificial intelligence and machine learning makes this possible, Aguilar argued.
Further, making allocations to thematics geared toward addressing individual goals and interests, and not purely relative returns, also helps clients stay true to their investment thesis – even when the market turns against them.
Indeed, investors need to buckle in for a wild ride if they are true believers in some themes. The poster child of thematic investing since the pandemic in 2020 has been Cathie Wood’s $7.7 billion Ark Innovation ETF. The product, which seeks exposure to companies behind disruptive innovation, boasted a 152.8% return in 2020, only to post a 23.4% decline last year and a 59.9% drop year-to-date in 2022, according to Morningstar data.
But Aguilar argued that active thematic ETFs like Ark Innovation don’t always share the same motives as index-based approaches to theme-based investing, like Schwab’s. Active management, by its nature, is designed to outperform, and portfolio managers are inclined to focus on the companies that have the best chance of doing that, even if its tie to the theme is not as strong. Indexes are bound by pre-determined metrics that dictate whether a company expresses a theme, and by how much.
Framing thematic investments as a purer way to articulate personal views may be a good way to tell the trend ETF story, but it remains to be seen whether investors will remember their personal fervor for the metaverse or solar power when cheaper, vanilla indexes outshine in the returns department.