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This article appears in the January 2022 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.

In providing concentrated exposure to emerging technologies, the challenge for fund companies is how to define the investable universe. So it is with Evolve Funds Group Inc. and Horizons ETFs Management (Canada) Inc. The Toronto-based firms each launched metaverse-themed ETFs on Nov. 29.

For the nascent metaverse industry, applications range from conferences to concerts to virtual-reality worlds where visitors can play games, view attractions together or otherwise interact.

Facebook raised the profile of the metaverse overnight in October when it changed its name to Meta Platforms Inc. and announced plans for multi-billion-dollar investments in three-dimensional interactive digital environments.

Meta is an obvious core holding for a metaverse fund. “Their existence requires them to be one of the pre-eminent destinations for social interaction online,” said Elliot Johnson, chief investment officer with Evolve and lead manager of the Evolve Metaverse ETF. “If they don’t continue to maintain that position, then they lose their dominance in terms of selling advertising and being a place where commerce is done.”

Some companies, like video-game providers, are considered “pure” metaverse plays. A prominent example is the online game host Roblox Corp., whose users create avatars to interact in a 3D digital environment.

But creating a diversified stock portfolio around the metaverse theme is subject to interpretation. These fund managers deem it sufficient to hold stocks that have metaverse exposure in some form.

The Horizons Global Metaverse Index ETF, for which Frankfurt-based Solactive AG created a 50-stock index, is the more broadly positioned fund. The index constituents encompass augmented and virtual reality technologies, metaverse creators, digital infrastructure, gaming, the digital marketplace, and digital payment processing.

To qualify, the ETF’s holdings “have to benefit from the adoption and usage of technologies that will grow and support the metaverse,” said Horizons president and CEO Steve Hawkins.

To identify eligible stocks, Solactive relies on its proprietary system of algorithms that scours online sources for company filings, news reports, social media posts and more. The maximum weight per name is 5%.

Evolve’s in-house investment team, meanwhile, takes a hands-on active approach to selecting companies from three categories: hardware, software and virtual platforms. The end result is 25 stocks, weighted equally and rebalanced quarterly.

For both ETFs, stock selection is about gaining exposure to the metaverse concept rather than seeking companies with strong growth or value metrics.

“We’re not considering those kinds of fundamentals, largely for the reason that you do have these large-cap companies that have lots of pre-existing businesses,” Johnson said. “We’re not trying to find out-of-favour companies that are going to do great because of the metaverse.”

Though there’s lots of buzz concerning the metaverse, the FOMO factor — fear of missing out – ought not to be of great concern to investors. That’s because there’s significant overlap between the holdings of the metaverse ETFs and broad U.S. stock indexes like the S&P 500 and the NASDAQ 100.

“These are not small businesses. These are real companies with real existing products and services; great franchises,” Johnson said. Along with Meta, other industry giants held by both ETFs include Alphabet Inc., Apple Inc., Microsoft Corp. and Walt Disney Co.

Though core large-cap holdings will remain, significant portfolio revisions are likely as metaverse-related businesses expand.

“The really great thing about the metaverse itself is it’s not limited in any way,” Hawkins said. “The metaverse today will be very different from the metaverse five years from now and 10 years from now, because of all of the infrastructure being built [and] because of all of the different opportunities.”