Exchange-traded funds (ETFs) have been a growing part of the investment universe, particularly those targeting specialist areas of the market, but while there are exciting opportunities there are also some that fund pickers are steering well clear of.
Inflows into global ETFs increased by 11.7% in 2020 compared to 2019, according to JPMorgan Asset Management’s latest TrackInsight Global ETF Survey, with environmental, social and governance (ESG) funds the most sought after. However, the range of ETFs on offer is vast and not all are worth buying, according to some.
Rob Morgan, Charles Stanley Direct pension and investment analyst, said that the heightened interest from investors in specialist areas had caused a stream of new product launches offering niche investments. This combined with fluctuating hype around certain areas has created more risk than investors realise.
“There is a tendency for ‘frenzies’ to accompany fashionable areas leading to unsustainable valuations,” Morgan said. Below, Trustnet looks at some areas market commentators said they would avoid.
Hydrogen
While ESG has been popular, not all areas of the sub-sector are equal and some offer more specific exposure to just one area like renewable and clean energy.
Hydrogen ETFs go a step further, but Morgan said he was sceptical as to whether investors should be buying something so niche.
He said that a strong case could be made for hydrogen becoming a significant part of the transition away from fossil fuel dependency, but warned that this was still in the early stages with only a handful of smaller companies working in the space, making it extremely risky.
Also, the lack of companies dealing purely in hydrogen meant that a hydrogen ETF would have to be diluted down with larger names that don’t have a pure focus on this asset, he added.
This makes it a toss-up of getting purer exposure to the theme by taking on a lot of risk in smaller companies, or compromising on the theme for better diversification and liquidity.
This is an example of “the product existing before the theme becomes fully ‘investable’,” Morgan said, and the expectation from keen investors that more hydrogen companies will be founded and developed over time.
Crypto
Another area investors might want to reconsider in ETFs is cryptocurrency.
Ben Yearsley, Fairview Consulting director, said that, like hydrogen, crypto had been a case study in “trendy and hot money”.
Both have the same problem, namely that they are based on stocks that are high risk, priced T extreme multiples of revenue and are extremely volatile, he said.
Cryptocurrency has been around for more than a decade, the poster child Bitcoin was founded in 2009 in direct reaction to the 2008 banking crisis. Back then, the idea was to have a currency decentralised from central banks.
The asset has received masses of attention the past 18 months, especially after major brands such as electric carmaker Tesla, digital payments company Square and cloud-provider MicroStrategy all made big investments into Bitcoin. As a result, the cryptocurrency’s price has increased by more than 300% in one year.
Bitcoin share price over 1yr
Source: Coinbase
There are now thousands of different cryptocurrencies indicating the high demand and interest in the asset, but while some view it as the next safe haven, others believe it is too speculative and volatile to serve this purpose.
Yearsley said is in the latter camp. He said: “Crypto is similar to currency speculation and that’s something I’ve never done for clients so why start now?”
He added that investors keen for exposure to this part of the market should look to some of the companies involved in the blockchain system and the underlying tech.
“I’ll leave that to the tech fund managers I can add to my portfolios,” he said.
Cannabis
Laura Suter, head of personal finance at AJ Bell, highlighted cannabis as another to steer clear of. The drug has been legalised in 18 US states, for either recreational use, medical use or both, following a wave of recent legislation.
In the UK cannabis is only allowed on medical grounds when prescribed, but following America’s easing on the substance some are campaigning for similar measures in the UK.
But this doesn’t mean it’s a fully realised investment option, according to Suter, who said it was “a highly-speculative, volatile area and a very unproven market.”
Suter explained that much of the increase in the share prices of cannabis-related stocks had been based on speculation that the Joe Biden administration would fully legalise the drug rather than “solid knowledge that the rules will be relaxed”.
Cannabis ETFs have varying rules around what they hold. Some are pure-plays, while others also hold larger businesses with just a small focus on the cannabis industry.
“If you did want to invest, it should only be for the very high-risk investor and with only a small portion of your portfolio,” Suter said.