Young & Invested: Are thematic ETFs worth it?
Walking the line between strategy and speculation.
Welcome to my column, Young & Invested, where I discuss personal finance and investing for Gen Z and Millennials.
This column aims to be a resource for young investors navigating an ever changing financial, political and social landscape as they try to build wealth. Tune in every Thursday for the latest edition.
Edition 28
One thing I’ve learnt over the years is that not all investments are equally exciting. Writing about the merits of dollar-cost-averaging into a broad based ETF is nowhere as interesting as sharing my thoughts on Bitcoin.
Financial markets are becoming increasingly narrative driven. Whether it’s AI, crypto or global defence – everyone wants in on the next big thing. So, it’s no surprise that thematic ETFs are enjoying their extended time in the spotlight.
Global ETF data platform Trackinsight, recently conducted an investor survey that found that over half of the surveyed investors planned on increasing their thematic exposure over the next six months.
Chart 1: ETF industry on overdrive. Source: Trackinsight. 2025.
As new products multiply faster, investors are inundated with the paradox of choice. Getting new products out is quickly evolving into an attention game.
Chart 2: Thematic funds have seen a steadier rise in net launches vs traditional counterparts. Source: Morningstar. 2025.
Why are they so popular?
There are currently over 40 thematic ETFs available on the ASX. Much like sector funds, thematic ETFs focus on global trends or themes that represent a market niche, with underlying holdings expected to benefit.
I believe there are two main reasons why people are drawn to thematic investing. One being psychological and the other being utilitarian.
The utility of a thematic ETF is straightforward. If you have conviction on certain trends or sectors, a diversified thematic ETF provides exposure through a basket of companies rather than take the risk of individual stock picks. But thematic funds tend to be volatile. The winners can reward you sizeably, but the losers can decimate your portfolio.
From a psychological perspective, we can be drawn to compelling stories, especially when winners are amplified through social media and investing platforms. Fear of missing out on these opportunities attract speculation-prone investors chasing the same short-term historical return propositions. However, research shows these funds rarely achieve a desirable outcome for investors.
Where they fall short
Higher fees and failure rates
As we can see from the chart below, both active and passive thematic funds charge higher average management fees than their non-thematic counterparts. When we look at asset-weighted fees, the difference is particularly striking with thematic funds charging fees many multiples (in the passive case, almost 6x) higher than non-thematic funds.
Chart 3: US average fund fees (%). Morningstar. 2024.
We know that fees lower returns. Therefore, over longer periods, the higher fees of thematic ETFs contribute to their poor performance. Chart 4 below shows thematic fund survival and success rate compared to global equities. In my opinion, these dismal long term success rates make it hard to rationalise a thematic fund over a bread and butter, broad based ETF.
Chart 4: Global thematic fund survival and success rate vs global equities. Morningstar. 2024.
Encourage poor investor behaviour
We’ve all bailed on a night out before. Whether you’re exhausted from the work week or don’t like the idea of standing in a club line in 5 degree weather – it happens. Naturally, that turns out to be the night a former One Direction singer shows up at the same bar.
Hit with a wave of FOMO, you rally the next weekend, convinced it’ll be a great time. Unfortunately, it ends surrounded by sweaty individuals dancing to the worst DJ in existence and longing for the comfort of your bed.
I think thematic ETFs can mirror this dichotomy. They make incredibly compelling stories, but that’s often where they end – as stories.
Dealing with niche strategies in a frenzied narrative-driven market can induce our worst tendencies. Morningstar’s Mind the Gap study showed that there was an average 1.1% lag on investor returns and fund returns for every dollar invested in US mutual funds and ETFs.
But if we dive deeper into the gap in sector equity funds (the ones that bear closest resemblance to where thematic funds would reside), the returns gap is 2.6%, the largest of the observed group. The gap is due to mistimed purchases and sales. Decisions on thematics are more likely to be driven by emotionally irrational decisions. Hence the larger gap due to poor investor behaviour.
Another perspective
Morningstar isn’t alone in this assertion. Competition for Attention in the ETF Space (2021), a study by Ben-David, Franzoni, Kim, and Moussawi also examined this phenomenon.
They consider ETFs to be the most prominent financial innovation of the last three decades. Big call – yes, but as an ETF enthusiast, I might be inclined to agree. Although I can’t speak for the decade before my existence.
The authors play with the idea that ETFs compete along two lines, price aka the ‘Walmart’ approach vs quality the ‘Starbucks’ approach which markets different dimensions of the product. In this case, broad-based market ETFs are the unsexy Walmarts of the ETF universe, and your sleek thematic product is akin to Starbuck’s seasonal crunchy ube macchiato – don’t ask me what that is.
They set out to examine whether a thematic or specialised ETF provided value in terms of exposure to successful investment ideas – what they found was damning. In short, their research concludes these ETFs failed to create value for investors and underperformed significantly.
The study points out that thematic ETFs are often launched when media coverage and investor interest is on the rise – of course, economically, this makes sense for fund providers. And the timing of this launch means the ETF is given maximum attention in a typically crowded marketplace.
The paper goes further to assert that some ETF issuers exploit investors biases and cater to poor behavioural tendencies. Given they’re launched after a run-up in the price of underlying assets, investors tend to extrapolate past performance. In other words, they show recency bias – the notion that more weight is given to recent events when making investment decisions.
The authors conclude that underperformance can’t be explained by higher fees or the intentional hedging of a portfolio. Rather underperformance is driven by the underlying assets being overvalued at launch. Providers create custom indices that reflect a theme of choice, backdate the index then display hypothetical historical performance in marketing materials.
And who can blame them? It’s a smart business model. If I could sell an ETF holding only Bitcoin and NVIDIA and backdate the index, I’d be on a yacht somewhere in the south of France.
The bottom line is that this practice amplifies recency bias, meaning investors are much more likely to buy in at inflated valuations and underperform in the long term. I’ve explored this in a past article on why Cathie Wood’s ARK Innovation ETF ARKK failed many of its investors.
So, what can we do with this? The most important thing is to be cautious of the shift towards attention-based strategies. Focus on the underlying value of the assets and why you’re thinking about purchasing them, rather than what returns they’ve recently achieved.
How to use thematic ETFs in a portfolio
The core-satellite approach is a portfolio construction strategy that involves picking ‘core’ funds that form the building block of your portfolio around which to construct the ‘satellites’.
These core funds are your low-cost vanilla options that track major markets, provide broad diversification and have minimal turnover. The purpose of this allocation is to anchor your portfolio towards consistent long-term growth.
On the other hand, satellite holdings are tactical, conviction-based positions used to bolster your overall returns or achieve another investing goal. They are often more volatile and in riskier or niche sectors. Given their nature, these should only comprise a small portion of your portfolio, but essentially form ‘play money’ to invest in opportunities without putting your broader investment goals at risk.
We can consider thematic ETFs as part of satellite holdings due to their targeted exposure, higher potential returns and investment rationale designed to appeal to widespread conviction. Picking the winners of an investing megatrend can be difficult. Thematic funds partially solve that problem by offering exposure to a target theme whilst diversifying away single-stock risk.
But it’s overly simplistic to attribute all thematic investing to performance chasing. Such funds are also a good opportunity for investors who want to align their portfolios to their values e.g. funds that have an emphasis on ESG measures.
Not everyone’s approach will be the same. There is string of considerations associated with core satellite that Mark and Shani explore in our podcast episode: should I allocate part of my portfolio to having a punt.
Concluding thoughts
I personally don’t own any thematic ETFs, but this is what works best for me. I don’t think thematic or sector-specific funds are fundamentally flawed. Many are grounded in long-term trends with genuine potential. However, given the narrower focus, higher fees and increased uncertainty, we should give more thought to the why of investing rather chasing the what.
It’s also important to review how the thematic ETF fits in the context of your broader portfolio. Existing diversified holdings may already provide some exposure without needing to take concentrated bets. For example, popular pick for broad market US exposure iShares Core S&P 500 ETF IVV has a heavy weighting (~35%) to the technology sector, therefore investors holding this ETF already have substantial exposure to technology-driven themes.
Consider whether the fund actually has the potential to help you achieve your long term goals. Or whether you’re simply jumping into what’s trending because of FOMO. Focus on understanding the rationale behind the theme’s popularity and whether there is structural support through factors like demographics, innovation or regulation.
