How to Use Thematic Funds
Thematic funds from ARK Invest and others have generated a lot of interest.
Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. Funds that invest in particular themes, ranging from artificial intelligence to cannabis, have flooded the market. Are these funds merely gimmicks, or can they be useful tools in an investor's kit? Joining me today to provide us an overview of some new Morningstar research about thematic funds is Ben Johnson. Ben is Morningstar's director of global ETF research.
Ben, thanks for being here today.
Ben Johnson: Thanks for having me, Susan.
Dziubinski: Ben, how has the number of thematic funds and investor interest in them grown over time?
Johnson: We've seen dramatic growth in thematic funds over the course of the past few years. In fact, if you look back over the three years through the end of March 2021, assets under management worldwide in thematic funds tripled to nearly $554 billion. That represented 2.1% of all of investors' assets that are invested in managed investment funds worldwide. That's up from 0.6% if you were to go back 10 years. What we've seen at the same time is that the menu of these funds has also grown. Just last year, we saw a record 237 new thematic funds launched globally. That's up from 167 in 2019. And if you look back to the end of March of 2021, worldwide there were 1,159 thematic funds available to investors around the world.
What we've seen is really that a lot of this has been driven by net new money, net new interest on the part of investors. So, if you look at the U.S. menu of thematic funds, in particular, more than $81 billion in new money flowed into U.S. thematic funds in 2020. And during the first quarter of this year, what we saw was the strongest quarterly flows on record. More than $35 billion flowed into thematic funds in the U.S. in the first three months of 2021.
Dziubinski: Now, what themes seem to be resonating most with investors?
Johnson: Well, it's a great question and there are really a variety of different themes that fall under this umbrella that range from advances in technology--so, think of things like electric vehicles, think of things like DNA sequencing to, on the other end of the continuum, you mentioned before, cannabis-themed funds. There are now psychedelic-themed funds. There are also more-timely themes, emerging themes that we've seen come up over recent months. Just in 2020, we saw three different work-from-home-themed ETFs that were launched, that were brought to the market in the U.S. The ones that have really resonated are the ones that tend to be more broader in scope, those that focus on a variety of different emerging themes. They tend to feature prominently in their legal names or their marketing materials words like innovation and disruption, which is really broad spectrum. It can apply across a variety of sectors, across a variety of industries.
The other subthemes that really have proved popular over the course of the past year-plus have been those with a clean-energy focus. As part of the excitement around infrastructure development, a green new deal, what we've seen is that investors have poured into green-energy-themed ETFs. In fact, if you look at one of those ETFs in particular, the iShares Global Clean Energy ETF--ICLN is the ticker for that fund--that fund grew 885% on an organic basis over the 12 months through March. It got so big it actually had to change its underlying index to accommodate its heft. So, very broad sort of innovation-, disruption-oriented thematic funds--those from the ARK family of funds in particular, which has seen tremendous growth. So, if you look at 2020 alone, ARK in and of itself accounted for one fifth of all of the money that flowed into all thematic funds. In the first three months of this year, it accounted for nearly one half of the flows into thematic funds. So, the themes part of it is the family, and in this case, it's a family that's produced tremendous performance and has seen absolutely torrential flows from much of the past year. And as I mentioned before, clean energy, another theme that has been very popular with investors over the course of the past year-plus.
Dziubinski: Let's talk a little bit about performance of thematic funds over time. What does that look like in general?
Johnson: Well, if you look at success rates among U.S. thematic funds, over the short term, they've done actually remarkably well. If you look back at 2020, of all of the thematic funds that are available to investors in the marketplace, 80% of them outperformed the Morningstar Global Markets Index during the calendar year. Now, why is that? They tend to lean into growthier names, smaller names, those names that really got a lift across the board last year during a year in which growth outperformed value by an absolutely massive margin. So, uniformly, almost uniformly across these funds, as should be little surprise, what you see is more of a growth bent--in some cases an ultra-growth bent--which really helped them over the short term and which helps to explain their recent popularity. They've performed remarkably well.
Now, that said, if you go back further in history, their track record really isn't anything to write home about. Over the trailing 15-year period, what we saw is that among the thematic funds that were available to investors 15 years ago, nearly half of them have since been closed and less than a third of them had both survived and outperformed the Morningstar Global Markets Index over the subsequent 15-year period.
Dziubinski: Given that longer-term performance, how might investors use thematic funds in a portfolio? Should they even be thinking about that or steering clear entirely of them?
Johnson: I think investors should know what they are getting into. I liken investing in thematic funds to placing a trifecta bet at the horse track. So, in the case of a trifecta bet, you are trying to get three things right. You are trying to get, in this case, the theme right. Is the theme real? Is it durable? You are trying to get the stocks right. Are the stocks in this fund, or the stocks in this portfolio, be it an indexed portfolio, be it a discretionary active portfolio, the ones that are going to capitalize on that theme today, tomorrow, and well into the future? And then, third, and perhaps most importantly, are the valuations right? Are these compelling values, or has the market already priced in much of investors' enthusiasm about whatever this theme might be? And what we see is that based on historical performance, much of investors' enthusiasm tends to be priced in by the time that there are one or more thematic funds targeting a specific trend, a specific theme that are brought to the market. So, investors should come in with eyes wide open. They should be choosy. But they can consider these thematic funds around the corners of their portfolios. Maybe if they've got some funny money set aside to take a more speculative position.
The other role I think they could potentially play for an investor's portfolio is as a single-stock substitute. So, investors might buy into a particular theme, but they might not have the resources or the inclination to really dig in and understand what are the best-of-breed stocks that are going to capitalize on that theme. So, if you like the theme but you don't know which stocks to pick, you might be well served to outsource that work either to a discretionary active manager or to a thematic index fund or ETF.
Dziubinski: Ben, thank you so much for your time today and perspective on this growing part of the ETF market. We appreciate it.
Johnson: Thanks for having me.
Dziubinski: I'm Susan Dziubinski with Morningstar. Thank you for tuning in.
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Ben Johnson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.