• There are three key aspects to a megatrend considered in developing thematic ETFs
  • Thematic investing seeks to capitalise on megatrends and long-term structural changes
  • Reducing single stock risk, thematic ETFs invest in a portfolio of companies offering exposure to a theme

Back in 1993, a research paper titled ‘Looking for the real Megatrends’ was published in the publication Futures.

It was written by futurist Dr. Richard A Slaughter and is an interesting read. Slaughter goes into the term Megatrends, first coined in 1982 by American John Naisbitt, and how by the 1990s it had become widely used.

Among questions posed in his abstract – “Is there any value in the concept of a ‘megatrend’? If so, how might it be used? If not, what pointers may be derived for the near-term future?”

Fast forward to 2022 and investors would be well aware of the term megatrend. Furthermore, just as ETFs have become an increasingly popular investment vehicle so too have thematic ETFs, enabling investors to capitalise on megatrends.

But what exactly is a megatrend and how do ETF providers decide what thematic ETF products to introduce to market?

Three key aspects of a megatrend

Global X ETFs head of distribution Kanish Chugh said there are three key aspects of a megatrend including:

  • Structural growth and innovation
  • Ability to disrupt an industry
  • Ability to provide change for economies and demographics

“You could have a megatrend around mobility which may be autonomous or electric vehicles,” Chugh said.

“You could have a megatrend around clean technology and then that could be further broken down to different tech themes like battery technology, hydrogen, or uranium.”

He said first and foremost is the overarching megatrend and how that can be defined. Key to a megatrend is government support.

“Any megatrend big or small needs to have government policy support because otherwise, it will not have long-term success or the ability to be a disruptor,” he said.

“Without government support, it may still be a megatrend but much more of a greenfield investment like battery technology 7 or 10 years ago. ”

Chugh said an example was electric car maker Tesla which was first founded in 2003.

“Who was looking to buy into those? It was innovators who were willing to buy into the unfounded technology,” Chugh said.

“Now we’re at a point with government policy around net zero, COP27,  there is this big shift.

“With government support comes corporate support, which leads to consumer support.”

Chugh said investors should think of a megatrend as having a cycle of 10 to 20 years plus.

“It has to be at least that 10 to 20-year time horizon,” he said.

Linking megatrends with thematic ETFs

There’s been considerable growth in thematic ETFs over recent years and GlobalX (formerly ETF Securities) has been at the forefront.

“We were among the first to launch thematic ETFs with some with our robotic and automation ETFs and our ACDC in 2017,” he said.

“They were all products founded in what is actually defined as a megatrend.”

Chugh said when developing thematic ETFs it’s all about research and there’s no room for following fads.

“It’s not a case of let’s launch an ETF on this or follow a fad because it’s the most talked about, rather research is the foundation of product development,” he said.

He said questions are asked like ‘what is the theme or megatrend which needs to be covered?’ ‘Do investors already have exposure to the megatrend?’

A big consideration for a thematic ETF is also defining an index.

“It’s not simply because a company has hydrogen in their name or talks about hydrogen for example,” Chugh said.

He said Twiggy Forest is a good example because he is a big promoter of green hydrogen but Fortescue (ASX:FMG) “is not wholly doing hydrogen but many other things.”

“If I want to invest in a hydrogen thematic do I want to be invested in Fortescue or invest in companies generating the majority of their revenue from hydrogen?” he asks.

“An ETF tracks an index and that index needs to be well thought out and withstand cycles, the test of times, questions, and due diligence done by investors.”

Capitalising on megatrends

BetaShares senior investment strategist Cameron Gleeson said thematic investing seeks to capitalise on the megatrends and long-term structural changes that reach into almost every part of our lives.

“It’s our view that demographic change, technological innovation, and climate change are the criteria for these megatrends that are reshaping the way we live, work, and play,” he said.

“When constructing a thematic exposure, we look for industries that will that leverage one or ideally more of these megatrends.”

Gleeson said as a start, BetaShares takes great care to ensure the theme is based on a long-term megatrend that will play out over the decades ahead – whether it be global cybersecurity, robotics, or even cloud computing.

“Further, we seek out industries that are either profitable or have a pathway to profitability and are able to take advantage of the structural megatrends that are reshaping the world,” he said.

“Finally, we make sure there is an investible pool of companies that can form the basis of a well-constructed ETF that investors can use as a pure-play exposure to a selected theme.”

Gleeson said thematic ETFs combine the benefits of an ETF – namely convenience, diversification, and transparency – with exposure to long-term structural changes in the economy and society.

“The key benefits of thematic investing are the long-term growth potential and the fact they are unconstrained by geography, sector or style bias – this gives investors greater scope to tilt their portfolio to the megatrends they believe have the most growth ahead,” he said.

Gleeson said further, investors are able to use thematic ETFs to reduce stock-specific risk by investing in a portfolio of companies that offer exposure to a particular theme.

“Also, thematic exposures are often, by their nature, not well represented in more core allocations so offer diversification benefits as part of an overall portfolio.

“Finally, investing in multi-decade structural change removes the temptation to trade on the latest fad or news cycle and focus on building long-term wealth.”

Thematic ETFs to complement a diversified portfolio

In terms of portfolio construction, Gleeson said investors should only use thematic ETFs as portfolio satellites to enhance returns.

“The portfolio core should be based on low-cost ETFs covering large-cap international and Aussie equities, fixed income, and other assets of this nature,” he said.

“For this part of the portfolio, investors could consider funds like our Australia 200 ETF (ASX:A200),Nasdaq-100 ETF (ASX:NDQ) or our Australian Composite Bond ETF (ASX:OZBD).

“Thematic ETFs can then be used by investors as the satellite component of their portfolio to tilt the portfolio towards genuine megatrends, such as alternative energy, electric vehicles, or artificial intelligence.”