Chart of the Week: You’re likely going to underperform with a thematic ETF
Data shows that thematic funds have generally lagged benchmarks, but they also cause poor investor behaviour.
This week’s Chart of the Week comes from our Manager Research team’s new report, Buyer Beware. The report runs through five tips for investors evaluating a new fund.
One of the tips shares some sobering data on thematic funds and what they’ve returned to investors. The analyst behind the report is Shamir Popat, Senior Analyst, Manager Research. He shares that a common pitfall when investing in new funds is jumping into whatever’s currently in vogue.
A better approach for investors is to ask themselves whether the new fund has the potential to serve a meaningful role in helping you achieve your long-term financial goals, or whether it is satisfying an itch that might not stand the test of time.
If you’re an investor trying to build long-term wealth, broad-based equity funds are usually what you’d reach for. Income-oriented investors might reach for fixed-income or dividend-focused funds. In contrast, very niche fund offerings built around hot trends tend to falter when the initial excitement fades, often leaving investors disappointed.
Thematic investing is a case in point. It has gained significant global momentum in recent years. These funds are not inherently flawed as many funds are built on long-term structural trends with genuine investment potential, but they call for careful consideration and a thorough understanding of the risks involved.
Our global colleagues explored these aspects in depth in the Morningstar Global Thematic Funds Landscape 2024.Two key findings stand out: Most thematic equity funds fail to beat a broad global equity benchmark, and over 60% of them have shut down in the past 15 years. That’s a sobering record.
Another Morningstar study, The Big Shortfall underscored this danger by showing that investors generally struggle with timing their investments, especially when it comes to more volatile or narrowly focused strategies. Over the past five years, thematic funds had a total return of 7.3%, while investors only earned a 2.4% return.
The report dives deeper into the potential causes of this gap. Either way, it is a large gap that results in poorer investor outcomes. This tendency is amplified in trend-driven products that lack broad diversification or long-term viability.
So, should an investor avoid thematic funds altogether? Not necessarily. Rather than jumping into what’s trending, focus on understanding the economic rationale behind the theme. An investor should gauge whether this theme is supported by structural, long-term drivers, like demographics, innovation, or regulation, or if it is simply riding a short-term wave. Additionally, it is also prudent to review whether an existing fund with a diversified core portfolio already provides some exposure to such themes without needing to take concentrated bets.
The full report with the five tips is available for Morningstar Investor subscribers.
You’re able to find previous editions of Chart of the Week here.
