It’s been a weird year for the exchange-traded fund marketplace. On one hand, the emergence of thematic ETFs has provided new investment opportunities. On the other hand, the rise of thematic investing hasn’t slowed the pace of ETF closures.

There have been 198 ETF closures in the U.S. for the year through early October, according to FactSet. These include thematic funds linked to legislative policies (the EventShares U.S. Legislative Opportunities ETF), organic food (the Organics ETF) and sustainable investing (the Columbia Sustainable Global Equity Income ETF). In each case, the promise of investing in narrow themes never matured.

Thematic funds generally fall into two key groupings: single theme and multi-theme.

The Direxion Work From Home ETF (WFH), which launched in June, is an example of a multi-theme fund. It targets four key themes: cloud technology, cybersecurity, remote communications and online work collaboration. The fund recently had nearly $122 million in assets, making it among the year’s best thematic funds by asset growth.

Other multi-theme ETFs with a longer performance history—such as ARK Invest’s product line focused on disruptive innovation—have delivered impressive results. Since 2014, ARK had amassed nearly $15 billion in its lineup of seven thematic ETFs.

Thematic ETFs are different from sector funds; the latter are usually derived from broader indexes. For example, the 11 industry sectors within the S&P 500 are a result of the S&P committee classifying and organizing stocks within the index according to their industry group.

In contrast, thematic funds are typically actively managed or linked to newly created indexes with the specific purpose of targeting a certain investing trend or theme.

And as you might imagine, the risk greatly increases as the investing themes narrow, so it can be a hit or miss proposition.

For example, the hype from a few years ago that 3D printing would totally upend product manufacturing hasn’t lived up to its promise from an investment angle. The ARK 3D Printing ETF (PRNT), which tries to capture this theme with a portfolio of 53 stocks, has significantly lagged the performance of both the Invesco QQQ Trust (QQQ) and the SPDR S&P 500 ETF Trust (SPY). Over the past five years, PRNT has registered a total return of just 29% while the QQQ fund logged 178% over the same period (through October 5) and the SPY fund returned 89.5% during that period.

Cybersecurity is another example of a promising theme with lackluster performance. The ETFMG Prime Cyber Security ETF (HACK) has gained just 91.4% during the past five years, which failed to beat QQQ and just barely outperformed SPY. In retrospect, the concentrated risk and volatility of owning cybersecurity stocks probably wasn’t worth it.

What Are The Lessons Of Investing In Thematic ETFs?
First, financial advisors should carefully monitor the thematic vehicles they choose for client portfolios. Instead of choosing higher-risk funds tied to single themes, ETFs that use a multi-theme approach can help to alleviate a single-pronged, hit-or-miss strategy.

Next, advisors should compare an ETF’s underlying holdings to other investments held in their clients’ portfolios. If there’s needless duplication in stock holdings, or if the ETF is just another large-cap fund posing as a thematic ETF, it’s probably best to take a pass.

Finally, thematic ETFs are usually best used as satellite positions complementing much larger core positions in broadly diversified funds.