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Marijuana to Metaverse: League of Flunking Specialized ETFs

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Marijuana to Metaverse
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Every trend can be used for monetization if proper resources are applied. From marijuana legislation to cult forming around the work-from-home culture, if a trend or a theme exists in the market, there is bound to be an exchange-traded fund for the same. Because the issuance cost of new ETFs is low and the competition among the fund issuer is intense, this financial innovation has flourished. 

Exchange Traded Funds: Timing & Trends

The last three decades saw thousands of new ETF launches. Recently the plethora of specialized ETFs challenged the imagination of investors. But the question remains, is the financial innovation in ETFs created value for investors? A study published by Francesco Franzoni, Itzhak Ben-David, Byungwook Kim, and Rabih Mousssawi suggests a different result. 

The study highlights that, on average, a new equity NFT could be a poor investment due to a risk-adjusted basis. The study points fingers at specialized equity ETFs, which mainly focus on specific industries or a particular theme. The last two decades made it clear that industry and thematic ETFs have underperformed the broad-based benchmarks by nearly 30% in the first five years of their inception. Of them, 3% were for their fees, while 27% were for the underperforming base assets. 

ETF providers try to ride the latest trend to attract new investors, thereby turning a passive product into an active bet over a theme. Post the success of the initial wave of ETFs tracking broad-based indices like the S&P 500 index, the competition intensified, and the fees declined. As a countermeasure, issuers came up with newer ranges of products, charging higher fees while tracking smaller segments. 

New generation ETFs

With the advent of the new generation came the Smart beta ETFs, made to mimic the investment approach rather than straight market capitalization. Then some ETFs based on industries and some thematic versions appeared. The latest version saw the emergence of Single-stock ETFs. 2020 saw new ETFs holding portfolios related to Covid-19 vaccines, telemedicine, and sports betting. 2021 saw BTC, EVs and Metaverse. 

Obviously, an ETF issuer has the goal of maximum revenues while designing new ETFs, and revenues are higher only when the fee rate and the assets that investors pour in are higher. With a buffet of NFTs available, newer ones must be characteristic to attract investors. Suppose the issuer manages to hit the right spot with its theme or cause, investors may not be much vigilant or sensitive to the price paid for the product. Amidst the slower market causing forced reconstruction, the bet is on specialized ETFs. 

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