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When thematic funds diverge

Differing returns illustrate the need for due diligence
March 31, 2022

Investors looking to make a play on the cyber security theme can go for more diversification than holding the likes of Darktrace (DARK) and NCC Group (NCC) alone, thanks to exchange traded funds (ETFs). L&G Cyber Security UCITS ETF (ISPY) and iShares Digital Security UCITS ETF (SHLG) both offer UK investors ways to access the trend. But a recent divergence in performance reminds us that such portfolios can be very different animals at times.

As of 28 March the L&G fund was up by 0.9 per cent for 2022, the result of an extremely painful January sell-off followed by a handful of rallies (and pullbacks) in February and March as the Ukraine crisis took hold. The iShares ETF has had a similar trajectory but fell nearly 8 per cent over the same period, putting some clear space between the two.

The exact cause of this difference is hard to determine, but it seems the L&G fund has enjoyed some sharper price spikes when cybersecurity shares have come into favour. FE data suggests it made a gain of nearly 14 per cent between 23 February and 2 March, a period that covers the first week of the Russian invasion. The L&G fund then fell back slightly before rallying by 12 per cent between 14 and 25 March. The iShares ETF has rallied strongly in each period but to a lesser extent.

Portfolio concentration might explain some of this. On 25 March, the L&G fund had a third of its assets in its 10 biggest holdings, including VMware (US:VMW), Check Point Software Technologies (US:CHKP), NortonLifeLock (US:NLOK), Splunk (US:SPLK) and Akamai Technologies (US:AKAM). The fund held 56 shares in total. iShares Digital Security, by contrast, had 18 per cent in its top 10 and 120 holdings in total.

The iShares fund also has a less focused remit – it targets companies exposed to “major structural drivers” leading to an increased need for digital security. The L&G fund targets companies actively engaged in providing cybersecurity technology and services, including those that develop the relevant hardware and software, and provide consulting and secure digital services.

This isn't the only divergence when it comes to popular themes. Ukraine has pushed the need for renewables back into the spotlight, and clean energy ETFs have rallied on the back of this. iShares Global Clean Energy UCITS ETF (INRG) and Invesco Global Clean Energy UCITS ETF (GCLX) are each up by just over a fifth in the four and a bit weeks since 23 February. But the Invesco fund fell harder before the Ukrainian crisis struck, leaving it on a 6.9 per cent paper loss between the start of the year and 28 March, versus a 2.5 per cent gain for the iShares ETF.

This is all very short-termist stuff, and it's worth noting that performance differences can certainly go the other way. While L&G Cyber Security has outperformed its iShares rival overall in recent years, the latter returned 17.4 per cent in 2021, more than double the return delivered by the L&G ETF. But these differences illustrate that thematic funds can be as idiosyncratic as active equity portfolios, and need as much due diligence – if not more.