How to Manage Risk and Generate Returns with Thematic Investments

Investors should consider targeted exchange traded funds that marry best-in-class disruptive equities with sophisticated options strategies to create downside market mitigation and enhanced upside potential.

In the recent webcast, Don’t Diversify Away a Good Idea: Rethinking Thematic Investing, Brian Kelleher, CRO, Simplify Asset Management, warned of the shortfalls of heavily relying on broad index-based funds like those that track the Russell 3000 Index. While the index provides instant diversification to the entire U.S. stock market, the strategy also dilutes exposure to innovative companies with greater growth potential.

For example, Tad Park, CEO and Founder, Volt Equity, highlighted a true champion in the innovative space: Tesla. He underscored the importance of data accumulation as the company is also the only one with a robust data engine to ensure that cars are constantly being updated with smarter A.I. In the autonomous driving category, Tesla has accrued a staggering amount of data from its low maintenance fleet, with 2 billion miles of driven data in store.

Park also pointed to the disruptions in fintech, such as digital payments that promote frictionless payments and new insurance companies that engage in digital acquisitions and digital claims. He argued that the insurance industry is ripe for disruption as the current value of the insurance market is about $1.35 trillion. Lemonade, a nascent disruptor, is only valued at $9 billion.

As the digital frontier expands, new industries like cloud computing and cybersecurity are also gaining momentum. Park highlighted the infinite scalability of data in cloud computing with emphasis on managed security and developments of A.I.-powered endpoint protection in cybersecurity.

Additionally, investors may even consider innovations that have fueled pop culture. Park pointed to the modular infrastructure behind social media and A.I.-powered recommendations in streaming audio.

As a way for investors to tap into these growing themes, Simplify has partnered with Volt Equity to launch four cutting-edge ETFs, including the Simplify Volt RoboCar Disruption ETF (VCAR)Simplify Volt Fintech Disruption ETF (VFIN)Simplify Volt Pop Culture Disruption ETF (VPOP), and Simplify Volt Cloud and Cybersecurity Disruption ETF (VCLO). The funds take concentrated positions in disruptive technology sector leaders while utilizing robust options strategies to enhance upside while limiting downside.

Paul Kim, CEO and Co-Founder, Simplify Asset Management, explained that the investment process begins with a first principles approach to identify the few companies poised to lead the disruption through technological edge and cultural innovation. The strategies include a concentration in ‘anchor’ disruptors, like Tesla as a play on the biggest innovators in their respective segments. The strategies also deploy a sophisticated option overlay to create convexity in the portfolio, with upside calls on anchors based on S-curve history and projection, along with downside puts on NDX to protect against broad market sell-offs.

According to Simplify, an investment strategy is convex if its payoff relative to its benchmark is curved upward. Convex investment strategies are expected to be highly correlated with the benchmark in typical market environments but diverge to the positive in extreme markets. However, convex strategies are expected to lag during quiet markets.

The downside convexity is a great way to protect capital against deep market drawdowns and can be deployed either strategically or tactically. Protection via convexity is designed to increasingly support a portfolio as a market drawdown worsens.

Meanwhile, upside convexity is beneficial for those investors who don’t want to miss out on the biggest of market moves, and similar to downside convexity, can be deployed either strategically or tactically. It is a valuable tool for those investors looking to enjoy the benefits of strong moves up while not committing excessive capital to risky assets or deploying outright leverage.

Financial advisors who are interested in learning more about thematic investment ideas can watch the webcast here on demand.