Young & Invested: Why these ETFs are likely to disappoint investors
A resurgence in thematic ETF inflow suggest that investors are ready to repeat the same old mistakes.
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 43
As a child, I had an unhealthy obsession with the movie Spy Kids. It’s now somewhat of a cult classic. I distinctly remember a scene where the two main characters, Juni and Carmen, came upon a set of futuristic jetpacks to escape villains in the last moment. My 8-year-old self couldn’t wait for the day when not only would I become a spy, but when these jetpacks would be part of my everyday commute to work.
Fast forward almost two decades, and my reality couldn’t be further removed. Instead of jetpacks, it’s a communal Benz (bus) and a train system that shuts down at the mere suggestion of rain. Apparently 5mm of water is our greatest technological foe. Anyway.
Back then I was certain jetpack technology was around the corner. The world was progressing faster than ever. It was only inevitable, right? This story is a lot like how I see thematic investing play out. Thematic funds are built around a singular theme or megatrend e.g. clean energy or cybersecurity and hold a set of underlying companies who might benefit from the uptake. They take our grand visions about the next big thing and sell them back to us with the promise of a first-class ticket to the ride megatrend. But it usually doesn’t materialise that way.
The odds of investors picking a winning thematic fund aren’t exactly flattering. Morningstar’s latest Global Thematic Fund Landscape for 2025 shows less than one in ten managed to both survive and outperform global equities over the long-term.
Source: Morningstar Global Thematic Fund Landscape. 2025.
With over 40 of these funds currently listed on the ASX, it’s almost guaranteed most investors will end up disappointed. Last week I looked at the drivers behind fund failure and the red flags to watch. Notably, a product that had overwhelmingly suffered from failure both in global and local markets were thematics. Yet despite the track record, inflows are rising again, suggesting investors may once more be getting lured back in.
A recent Morningstar study found that in the three-year period ending November 30, 2024, the average dollar invested in thematic funds lost around 7% per year. To put that in perspective, the S&P 500 gained more than 11% per year over that span.
What drives this underperformance? I’ve previously unpacked the phenomenon in this article, but in short, higher fees and poor timing has led to the demise of many thematic investments. That’s not to say there haven’t been big winners. Aptly demonstrating this duality, we see some of the best and worst performing ETFs this year to date have been thematics.
Why should we care right now?
If you’ve skimmed the headlines lately, you’ve probably seen the doomsday chatter about share market valuations hovering near all-time highs. Every minor blip of news is treated like the tip of the iceberg. Investors are bracing for a steep correction or at the very least, lower future returns.
Nevertheless, markets don’t dictate our day-to-day existence. We still go to work, raise families, catch up with friends and pursue our goals, regardless of whether the ASX is up or down this week. What markets do dictate however, is the feasibility of those goals. In times of mass uncertainty or pessimism, where do we go to ensure our investment goals stay on track? Often, the answer is into the hands of opportunists, waiting to pitch you their latest tactical allocations and corresponding new products.
2021, dubbed the year of thematic ETFs, saw the products explode on the back of opportunities created by the Covid-19 pandemic. However, they experienced a substantial fall from grace in the corresponding years. After expanding 175% over 2020 – 21, global thematic fund assets fell 45% over the subsequent two years in what became a painful correction for enthusiasts.
It now appears the products might be back in vogue with AUM recently hitting a three-year high of USD 779 billion (Q3 2025), which is just 15% below the 2021 peak.
Seeking false comfort
Admittedly, I can take a bit of a holier-than-thou stance when it comes to my love for ETFs and my disdain for stock-picking. But I’m not sure my sentiment extends to the world of thematic funds. Although there is no right or wrong way to invest, the odds of choosing stocks that consistently beat the market are thin, given most long-term gains come from just a handful of companies.
However, investors now face a dilemma. If you are in the camp that believes broad markets are set to trend down, you may look for different places to try and generate strong returns other than vanilla ETFs that have done well recently. If you have an investment goal that requires aggressive returns, there’s a persistent argument to look elsewhere. The pitch for thematic ETFs is that they are a way to position a portfolio to potentially outperform traditional indices over the medium term. Picking individual stocks to complement a portfolio might also achieve this.
The trade-off is that investing in individual stocks present a type of risk that’s entirely avoidable. This is referred to as idiosyncratic risk and is tied to the unique circumstances surrounding the company you’re investing in. It can be anything from a CEO scandal to a failed product. Such events can be devastating for a single stock but typically don’t have a profound effect on the broader market (mega-caps might prove an exception).
Broad-based ETFs eliminate this idiosyncratic risk by investing in a handful of companies that can smooth out those one-off disasters. This way you’re only exposed to the risk of the overall market moving up or own. The issue is that thematic ETFs reintroduce idiosyncratic risk. Despite being packaged as diversified products, in reality they’re concentrated bets on a narrow, often speculative slice of the market. If one of the companies in a thematic fund stumble with a regulatory setback for example, there’s a good chance the entire ETF will feel the impact.
If you wish to capitalise on a megatrend or position your portfolio to outperform, undoubtedly a thematic fund offers more diversification than picking single stocks, but it’s debatable whether something that only has marginally better odds than individual stocks with a higher ongoing expense is worth betting on.
A cautionary tale
AI is increasingly being described as the defining investment theme of our era. The narrative is incredibly compelling. Over the trailing three years, such funds have been buoyed by the continued strength of the Magnificent Seven and other AI-adjacent stocks.
But those who cannot remember the past are condemned to repeat it. It’s not long ago that clean energy was touted as the darling of thematic investing as it rode a wave of political support and investor enthusiasm. Unfortunately, these funds have been a casualty of the broader cooling in sustainability, with assets falling more than 40% from peak to trough over the trailing three years. It appears they’ve made a slight rebound to 2023 levels, however it’s unclear if sentiment will stick.
I’m not here to speculate on which themes will stick and which won’t. The point worth noting is that investors play a guessing game of constantly betting on the next ‘sure thing’. And this game is rarely won in the long term.
Concluding thoughts
There are a couple points I want to underscore here. Despite occasional bursts of strong performance, the long-term odds of picking a thematic fund that both survives and outperforms an index remain slim. That’s not to say themes are automatically absent from most portfolios. In fact, most investors who hold a broad fund like iShares S&P 500 ETF IVV already have a thematic tilt toward technology and AI which dominate the index by sheer size. That’s why it’s important to check your portfolio for exposure overlap before adding another fund to the menu.
Successful thematic investing depends on fulfilling two difficult conditions. Firstly, the theme should prove enduring and evolve into something that meaningfully shapes the world. You also have to pick the right instrument to effectively capture that growth. Even if both of these are met, an over-looked challenge remains.
Ultimately, the key question is whether a theme will deliver more than consensus expectations. Markets are forward-looking and reflect collective judgement. To beat this, you must have some sort of investing edge. Jumping on a hyped thematic ETF is not one of them. Thematic ETFs are frequently launched after a surge in the underlying assets, meaning much of the optimism is already priced in. This makes the hurdle for success and strong future returns even higher. Whilst it may feel like you’re getting ahead of the curve, it’s likely many investors are right there with you.
