Thematic funds focused on narrow economic niches and secular growth trends can be cool, fun and sexy. But does that make them good investments?
Yes … and maybe not-so-yes, depending on the fund, the fees charged and how far back the data goes, according to a recent report from Morningstar. The investment research firm’s “Global Thematic Funds Landscape” report plumbs the depth of these products, which are hyper-focused on areas from blockchain and cannabis to genomics and hydrogen energy, as well as numerous other themes. Some thematic ideas are gimmicky and short-lived (such as the exchange-traded fund that tracked the performance of official corporate sponsors of the major North American professional sports leagues), while many others have some real meat on the bone.
Morningstar’s definition of a thematic fund is that its holdings have exposure to one or more investment themes tied to macroeconomic or structural trends—such as demographic shifts or technological advances—that transcend the traditional business cycle. For the purposes of its report, Morningstar focused on equity mutual funds and ETFs and it excluded fixed-income funds.
Its thematic universe comprises four main categories. One is technology, which includes areas such as artificial intelligence and cybersecurity investments. The second is the physical world space, which focuses on things such as renewable energy and the transition to the green economy. The third category, called “social,” runs the gamut from plays on consumer trends to the work-from-home movement. And the fourth category, called “broad thematic,” deals with future trends and transformational changes that will affect investing.
Add it up, and global assets under management in these funds more than tripled to $596 billion over the three-year period ended in March 2021. That was 2.1% of all assets invested in equity funds globally, where 10 years ago that number was only 0.6%. And a record 237 new thematic funds launched worldwide in 2020, up from 167 the prior year.
The technology category had corralled $323.3 billion in assets as of March, by far the largest among the four broad thematic groupings. Meanwhile, the energy transition theme is the largest single category with $74 billion in assets.
Europe has the biggest share of the thematics space, and most thematics globally are actively managed. But the U.S. market bucks that trend, with 63% of U.S.-listed thematic funds tracking an index.
The largest thematic fund provider is Swiss asset manager Pictet Group, while U.S.-based Ark Investment Management’s recent phenomenal success (in spite of its stumble this year) make it a strong number two player.
Globally, more than two-thirds of thematic funds outperformed global equity markets in the year ended March 2021. “However, this success rate drops to just 22% of thematic funds when we look at the trailing 15-year period, and 57% of the thematic funds were closed during the period,” the report said.
Morningstar puts part of the blame for that spotty longer-term track record on the fees charged by thematic funds, which tend to be higher than those of non-thematic funds.
U.S. Market
U.S. thematic funds garnered more than $81 billion in 2020, and were on pace to top that this year with first-quarter flows of more than $35 billion. Morningstar data starting from 1994 show that thematic fund launches flourish in bull markets and take a breather in down markets, which intuitively makes sense because there's not much demand for new investment products when people’s existing products are crashing.
But few thematic funds in the U.S. have been boffo success stories when it comes to gathering assets. Morningstar says the 10 largest U.S. funds controlled a little less than half of all U.S. thematic fund assets through this year’s first quarter.
That said, thematic funds don’t have to be billion-dollar behemoths to provide investors with effective and efficient exposure to the economy’s cutting-edge nooks and crannies. As we’ve seen recently with some of Ark’s ETFs, a fund’s size, coupled with its focus and concentrated holdings, can be detrimental at times.
In its report, Morningstar says the laser-like focus and higher risk profile of thematic funds make them best suited to complement rather than replace core holdings. It also suggests that the narrow focus of these funds makes them a suitable substitute for single-stock selection for investors who are interested in a particular theme but lack the time or resources to research individual companies.