Global research house, Morningstar, has prepped investors for disappointment amid a ‘thematic’ fund boom.
In a new report on the sector, the researcher notes that while thematic funds have experienced record growth in recent years as well as outperformance, history suggests the good times won’t last for long.
“Over the past 15 years, more than three fourths of thematic funds globally have shuttered and just one in 10 survived and outperformed,” the Morningstar study says.
“These figures paint a bleak picture for investors. They suggest that the odds of picking a thematic fund that survives and outperforms global equities over longer periods are firmly stacked against them.”
Despite the historical evidence, theme-based investments – often dressed-up in exchange-traded fund (ETF) clothes – have taken off in the last couple of years with both inflows and product-creation at record levels.
“Investor interest in thematic funds has increased dramatically in recent years, particularly since the beginning of the global coronavirus pandemic,” the Morningstar report says. “In the trailing two years to the end of 2021, assets under management in these funds have grown nearly threefold to $806 billion worldwide. This represented 2.7% of all assets invested in equity funds globally, up from 0.8% 10 years ago.”
And during the three years to the end of 2021 thematic fund investors have also been rewarded in aggregate with outperformance given more than half of the strategies both survived and beat the Morningstar global equities index.
However, theme-based funds tended to underperform over the 12-month period while the long-term record for the style is woeful.
Morningstar counted about 2,000 thematic funds in action at the end of 2021, including 589 that “debuted globally in 2021, more than double the previous record of 271 new launches in 2020”.
“Historically, the number of thematic fund launches has been positively correlated with the performance of the broader equity markets,” the report says. “The number of new thematic launches rose in the run-up to, and peaked immediately prior to, both the dot-com bubble and the global financial crisis before trailing off in the years that followed.”
Long-term thematic fund underperformance is partly down to high fees, a phenomenon common to both active and passive strategies in the sector, according to Morningstar.
“The difference is particularly striking when we look at asset-weighted fees, especially as the most popular thematic funds charge fees many multiples higher than those of the most popular non-thematic funds,” the paper says.
Based on its own methodology, Morningstar lists about 200 sub-themes currently on offer to investors, grouped under four main categories – technology, physical world, social and broad.
In NZ the NZX-owned Smartshares recently launched two thematic ETFs – covering robotics and healthcare – while another passive fund provider, Kernel Wealth, also joined the trend with its electric vehicle and ‘moonshots innovation’ strategies.
Kenneth Lamont, Morningstar manager research analyst, says in an article that thematic fund “buyers should beware”.
“These funds are often designed more with saleability in mind than investment suitability. Many cross the border into gimmick territory. Examples abound. Whiskey ETF, The Kids Fund, and StockJungle.com Pure Play Internet are just a few that have come and gone over the years,” Lamont says. “Investors have often piled into these funds at precisely the wrong time, only to be disappointed. Investors mulling thematic ETFs should think long and hard about whether a particular theme has long-term investment merit or if it is a mirage.”