Chapter 5 : Thematic ETF liquidity
SocGen ’ s Lemaire : Thematic indices compete for liquidity
Why liquidity is important in the thematic ETF space
Author : Jamie Gordon
Sebastien Lemaire , head of ETF research at Société Générale , has warned there is market-moving potential in the thematic ETF universe .
Speaking at ETF Stream ’ s Big Call : Thematic ETFs event , Lemaire said thematic product usage “ increased dramatically ” at the beginning of 2020 , with more than 120 new launches in Europe since the beginning of the pandemic .
This explosion of new entrants means “ thematic indices are now competing for liquidity ”, Lemaire warned . “ As an ETF investor , if you want to get exposure to something like renewable energy , you have the choice of 46 indices . EVs , 23 . Fintech , 11 . Sustainable water , 10 ,” he continued .
The S & P Global Clean Energy index – the world ’ s secondmost popular thematic strategy – is only one of 46 benchmark options within its theme but is tracked by five different ETFs domiciled across the world .
When building a thematic index , Lemaire said there are three interconnected “ pillars ” to consider – purity , an index ’ s riskreturn patterns and liquidity .
With many thematic benchmarks adopting either modified market-cap or equalweight approach , they tend to modify the liquidity profile of the free float market-cap-weighted underlying market .
“ For some thematic indices , the number of eligible pure-play stocks may be limited ,” Lemaire said . “ The risk of purity is to have a limited number of eligible constituents and this is something index providers aim to avoid .
“ A limited number of constituents may also lead to index concentration . To reduce this risk , the index provider may create single stock weighting caps , however , those caps tend to overweight smaller or midcaps versus larger caps – they may lead to a lower liquidity profile for the index .”
Should an index that is skewed to smaller companies
Number of available ETF underlying indices by theme
50
40
30
20
10
0
46
Renewable Energy
27
Al & Robotics
23
Electric Vehicles & Future Mobility
16
Cannabis
15
Video Gaming & E-Sports
14
Digital Assets
Cloud Computing suddenly welcome large sums of inflows , there is a risk these small players may end up being “ materially owned ” by ETFs . This also creates moments of significant volatility on index and ETF rebalance days .
“ Imagine a stock that is owned 10 % by several ETFs tracking the same benchmark ,” Lemaire said . “ Then imagine the benchmark rebalances and deletes this stock . Brutally , 10 % of the market cap of that stock will be sold by the ETFs tracking the benchmark .”
Such a scenario played out as the S & P Dow Jones Indices ’ clean energy index saw a “ flurry of inflows ” during the US presidential election period in 2020 . At the start of last year , SocGen noted three ETFs tracking the index
13 13
Sustainable Urban Development
11
FinTech
10 10
Cyber Security
Sustainable Water
9
Sustainable Food
8 8
Blockchain
5G
Source : SocGen
22