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Why Traditional Weighting Works With Thematic ETFs

This article was originally published on ETFTrends.com.

Thematic ETFs are anything but traditional, but Global X, one of the largest issuers of thematic ETFs, believes weighting stocks in thematic ETFs by market value is an approach that serves investors well.

The Global X Internet of Things Thematic ETF (SNSR) , the first exchange traded fund dedicated to IoT investing, is one of Global X's thematic ETFs that uses a cap-weighted methodology.

SNSR is considered a thematic ETF. Thematic strategies tend to be alpha-seeking, have a long time horizon and are growth oriented. The thematic investments also transcend classic sector, industry and geographic classifications as many overlap.

SNSR, which is two years old, targets the Indxx Global Internet of Things Thematic Index. IoT “includes the development and manufacturing of semiconductors and sensors, integrated products and solutions, and applications serving smart grids, smart homes, connected cars, and the industrial internet,” according to Global X.

Global X outlines some key reasons why investors may want to put cap-weighted indexes on their side when considering thematic ETFs.
“The key reason why we opt for the market cap weighted-based approach is to be more representative of industry dynamics,” according to Global X research. “We view many themes as sector disruptors, or new industries that are challenging existing paradigms. In such emerging industries there is still much to be settled.”

More Perks With Cap Weighting

Many thematic ETFs are equal-weight funds, which exposes investors to smaller companies in growing market segments. However, not all of those companies will prove to be winning investments. There are other risks with equally weighting thematic ETFs.

“Which company will be the dominant robotics maker in 20 years? Which company will struggle and go bankrupt?,” asks Global X. “With a market cap weighted approach, we gain more exposure to companies as they begin to dominate an industry and reduce exposure to those that are failing. By contrast, an equal weighted approach is forced to sell exposure to companies as they grow and buy those that struggle.”

The average market value of SNSR's components is nearly $28 billion and its top 10 holdings include some well-known companies, such as Cypress Semiconductor (CY) and Dow component Cisco Systems Inc. (CSCO) .

“While some might argue that in the aggregate smaller companies offer higher growth opportunities than larger companies and therefore warrant more exposure than a market cap weighting scheme offers, we do not always find this to be the case in disruptive industries,” according to Global X. “Using history as our guide, recent powerful themes have demonstrated that larger companies enjoy enormous benefits due to economies of scale and network effects.”

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