Niche ETFs are a relatively new and rapidly expanding financial product category. In today’s market, these ETFs are becoming increasingly important. The definition of a Niche ETF can differ slightly among investment professionals. They are, in essence, a thematic ETF that enables investors to participate in a very specialized market niche.
- Niche ETFs defined
- Key considerations
- How to invest in niche ETFs
- Top picks for niche ETF investments
- The bottom line
While a lot of investors focus on a small number of investments, such as blue-chip companies and index funds, there is a vast ecosystem of alternative investments and specialty products available to suit nearly every investment approach. After all, there are more than 7,000 distinct ETFs available worldwide.
The transition from old to new trends appears to have been expedited by Covid-19. Traditional names in retail, for instance, appear to be losing ground to e-commerce at an even faster rate than before. Accelerated adoption of digital services has benefited the tech sector, while healthcare companies have also been boosted.
Niche ETFs have the capacity to invest in a wide range of industries and market capitalizations. This provides for variety in the index’s underlying elements.
Of course, sometimes the simplest investment techniques are the best. However, if you’re looking for unique investment alternatives or just want to see what’s out there, read on.
Niche ETFs defined
Niche ETFs, essentially under the thematic ETF umbrella, track macro trends while focusing on a subset of stocks that fall within a certain theme or industry. They are, at their core, a theme-based mechanism for an investor to participate in a very specialized market area.
Many factors have fuelled the demand for niche ETFs, including the fact that they are easy to understand, relate to, and invest in. They also help investors define and narrow their focus, provide diversification, and are frequently geared towards trends that are both propelling and unsettling the economy.
Niches can be a small market segment or the smaller sub-segment of a single sector. For example, technology has recently attracted a lot of investment interest. The technology sector is regarded as a powerful, broad-scoped general thematic investing category. When a sector is paired with multiple drivers and exposures that might carve out a more specific emphasis, niches are formed.
Key considerations
There are certain crucial aspects to keep in mind before diving into niche ETF investing.
First of all, long-term performance can be difficult to predict. Because niche ETFs are emerging, investors may be forced to have faith and take a risk in terms of performance.
Many specialty ETFs have little or no history. Though past performance does not guarantee future results, a track record allows us to see how closely an ETF matches the assets it invests in. Investors may pay a hefty price for those with a significant tracking error.
Volatility is a key issue where thematic ETFs are concerned. Thematic ETFs are more volatile than the more widely diversified ETFs due to their tight focus. As a result, they shouldn’t be the main focus of your core portfolio.
Most of the time, a wide sector will be less volatile than a narrower industrial group or theme fund. The theme fund can be thought of as a bridge between a broad basket of sector companies and a single stock, which is likely to be the most volatile of all.
Despite volatility being a concern, it can be minimized by smart asset allocation. Thematic ETFs can provide tremendous value in terms of flexibility.
This is because the expansion of the themed ETF industry has been so phenomenal that virtually no theme is considered “too far out there.” This provides investors with a great deal of choice; for example, if you’re interested in a certain segment of the video game market, there are lots of ETF possibilities available.
How to invest in niche ETFs
First and foremost, do not make any rash purchases. Choosing a niche ETF requires extra caution to ensure you’re targeting the ideal industries.
When hunting for niche ETFs, it’s a good idea to consider a variety of factors. Firstly, ensure that you have a thorough understanding of the industry in which you intend to invest. Second, identify trends.
It may become easier to detect developing niches that are likely to succeed when cultural norms shift. If you can recognize one, investing in a specialized ETF rather than a single company to capitalize on that trend could be a huge success.
Top picks for niche ETF investments
IQ Merger Arbitrage ETF (MNA)
MNA is a straightforward ETF used to profit from merger and acquisition trends. This New York Life-managed ETF aims to make money by investing in worldwide companies that have had a formal declaration of a takeover by an acquirer. The idea is to profit from the “arbitrage” between the price when the deal is publicized and the final valuation at the transaction’s close.
First Trust Cloud Computing ETF (SKYY)
This ETF invests in firms that profit from cloud computing, a market segment that provides on-demand services such as data storage and computational power over the internet. As of Oct. 20, 2021, the ETF has a 28 percent annualized return over the previous five years.
Global X Millennial Consumer ETF (MILN)
The shift in purchasing habits among the millennial age group, which has increasingly more spending power, is reshaping the US economy. MILN’s holdings, including e-commerce behemoth Amazon.com Inc. (AMZN), are attempting to capitalize on these trends.
Global X Robotics & Artificial Intelligence ETF (BOTZ)
This index ETF invests in firms that stand to benefit from the rise of robotics and artificial intelligence, including industrial robots, automation, and self-driving vehicles. The ETF has returned roughly 20% annually over the previous five years as of Oct. 20, 2021.
VanEck Social Sentiment ETF (BUZZ)
BUZZ is an interesting thematic ETF to look at in 2022 after the “meme stock” craze of the previous year. This VanEck product aims to create a portfolio based on the most popular stocks on social media. It rebalances on a regular basis to favor large-cap US companies with the highest level of favorable investor sentiment and bullishness in social media, blog posts, and other such media.
ARK Genomic Revolution ETF (ARKG)
Medical technology is one of the most fascinating fields, and this actively managed fund is searching for firms that are working on gene editing, stem cells, and other such targeted medicines to extend and improve human life through technical and scientific advancements.
VanEck Low Carbon Energy ETF (SMOG)
This VanEck fund aims to track the performance of renewable energy stocks as a whole. Wind, hydropower, solar, biofuel, hydrogen, or geothermal technology companies, as well as smart grid technology producers, are among the fund’s assets.
The bottom line
Investing in thematic ETFs involves both higher risks and, potentially, higher rewards than investing in the general ETF market. Investors should be mindful of the risks associated with investing in these specialty ETFs, but if done correctly, thematic ETFs can give you exceptional returns. Remember, the criteria, index composition, and degree of specialization of the ETF should all be considered before making your decision.
Long-term investors who want to build wealth over time can use niche ETFs as part of a core-satellite strategy, in which they keep broad indexes as the foundation of their portfolio and have smaller stakes in specialist ETFs they believe will perform better over time.
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