Thematic funds have yielded “disappointing” returns in the past five years – particularly energy transition funds - but poor judgement by investors is to blame.
Fund data provider Morningstar said there had been a “concerning trend” in the thematic funds sector, which has more than doubled its global assets under management since 2018, driven by interest in themes such as AI and ageing populations.
Poorly timed buys and sells saw investors lose more than two-thirds of total returns, the firm said in its ‘The Big Shortfall’ report.
Thematic funds delivered average total returns of 7.3% annualised over the five-year period ending on June 30, 2023. Yet investors earned only a 2.4% return when the impact of cash inflows and outflows was considered.
This means investors suffered a 4.9 percentage point annual return shortfall that stemmed from mistimed purchases and sales.
A combination of volatile return profiles, low- or no-commission trading, and intraday trading capabilities in thematic ETFs “can encourage the worst type of investor behaviour”, resulting in poor investment outcomes, Morningstar’s report said.
Kenneth Lamont, senior manager research analyst at Morningstar, said: “As a global cohort, thematic funds have yielded disappointing investor returns over the past five years, with a staggering 4.9% investment gap. Unfortunately, the narrative is one of poor timing, as over two-thirds of total returns slipped away.”
Return gaps were far wider in ETFs than in thematic mutual funds due partly to ETFs' tendency to be more concentrated.
“Investors, collectively, have shown themselves to be poor market-timers, especially when buying and selling more targeted volatile funds compared to their more diversified counterparts,” said Lamont.
A case in point is the iShares Global Clean Energy ETF pair – which has Europe and US-listed versions - and saw $5.8 billion of inflows between November 2020 and January 2021 following strong performance that was probably linked to Joe Biden’s election to US president in the third quarter of 2020.
The new investments didn’t benefit from the preceding months’ gains. While the index tracked by the ETFs returned 17.6% annualised in the period of study, the annualised return for investors who bought the funds over the same period was a negative 5.5%.
This means there was a “colossal” 23% investment gap between what the fund returned and what investors got, says the Morningstar report, noting the strategy has lost half its value.
“The large return gap seen across the thematic fund universe years can broadly be characterized as one large binary bet that went wrong,” the report concludes.
Lamont urges investors to be more patient and disciplined and said a buy-and-hold thematic strategy is more likely to deliver superior outcomes for most investors.