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This article appears in the February 2021 issue of Investment ExecutiveSubscribe to the print edition, read the digital edition or read the articles online.

A January research paper from Ohio State University slammed specialty ETFs for poor risk-adjusted returns, high fees and lack of diversification, concluding that such funds “deliver a negative alpha of about –4%” annually.

“[T]hese [specialty] products compete for the attention of unsophisticated investors who chase past performance and neglect the risks arising from … under-diversified portfolios,” the paper states. “Specialized ETFs, on average, have generated disappointing performance for their investors.”

But Canadian ETF providers take issue with that notion, contending that ETFs with innovation themes are sustainable and that thematic funds can be beneficial when used appropriately. The returns of Canada’s top-performing thematic ETFs add credibility to that argument.

At the top of the Canadian-listed performance charts in 2020 was the Emerge ARK Genomics & Biotechnology ETF, which returned 156.9% for the year, according to Morningstar Canada. All five Emerge ETFs, managed by a New York-based ARK Investment Management LLC team led by Cathie Wood, returned at least 100% last year.

Other triple-digit winners in 2020 included the Blockchain Technologies ETF, managed by Oakville, Ont.-based Harvest Portfolios Group Inc., up by 151%; the Horizons Big Data & Hardware Index ETF, up by 117.2%; and the Evolve Automobile Innovation Index Fund, which gained 111.8%.

The Ohio State skeptics and bullish ETF promoters agree that specialty ETFs, particularly those that are tech-related, are hot stuff these days. Several new specialty offerings have been rolled out this year.

Among the most ambitious is a suite of five ETFs from BMO Asset Management Inc. based on MSCI innovation indexes covering themes such as genomics, next-generation internet and financial technologies, and another ETF devoted to clean energy. Other new entrants include the Horizons Psychedelic Stock Index ETF, which invests in life science and pharmaceutical companies developing therapeutic uses for psychedelic compounds, and the Evolve Cloud Computing Index Fund.

Toronto-based Evolve Funds Group Inc. looks for a long-term investment thesis when creating new products. Because of the lack of historical data on innovative technologies, “there’s definitely a subjective element that goes into” Evolve’s strategy, said president and CEO Raj Lala.

For example, the Evolve Cyber Security Index Fund (whose hedged and unhedged listings reported three-year annualized returns exceeding 30%) assumes cybercrime will continue to grow over the next decade, with cybersecurity becoming non-discretionary spending for every major company and government agency. The Evolve fund provides “pure-play access” to a specific theme and companies that generally aren’t in the major market indexes, Lala said.

Steve Hawkins, president and CEO of Toronto-based Horizons ETFs Management (Canada) Inc., pointed to broad economic and societal trends that he expects will sustain the returns of technology ETFs. “People are going to continue to work from home,” Hawkins said. “People are going to be significantly more interactive using computers. It’s hard to find a reason why you should not be continuing to invest in technology as a whole.”

By investing in specialty ETFs, investors can quickly access a subsector or investment theme while diversifying among several stocks, Hawkins added. “I don’t want to take the risk on individual names, especially in blockchain technology and cryptocurrency,” he said, “because I have absolutely no idea which one of those is going to be the next Coke or Pepsi.”

Lending some credence to the Ohio State paper’s criticism of thematic ETFs’ poor risk-adjusted returns — or negative alpha — is the highly erratic performance of cannabis-themed ETFs. The largest and oldest of those is the Horizons Marijuana Life Sciences Index ETF. The fund’s net asset value more than doubled to $24 in September 2018 before plunging to $5 in March 2020 and subsequently rebounding to $14 in early February of this year.

Hawkins said specialty ETFs give active traders a “liquid, efficient option” for getting in and out of marketplaces such as cannabis, and can be a tool for short-, mid- or long-term investing.

Toronto-based Emerge Canada Inc. aims to outperform index-style approaches to thematic investing. “Active management is really coming out miles ahead,” said Lisa Lake Langley, Emerge’s president, CEO and founder, pointing to her firm’s stellar returns to date. ARK’s team includes analysts who have backgrounds in areas such as genomics and various engineering disciplines. “Because they have that expertise, they know how to pivot and react to news,” Langley said.

While Langley acknowledged that investments in innovative companies can be volatile, she rejected the notion that investors aren’t well served by specialty ETFs.

“We see clients diversifying and advisors advising clients to diversify and start to allocate toward innovation,” Langley said. “[Innovation is] becoming almost an asset class.”