A damning assessment of thematic ETFs

Academic study found thematic ETFs deliver an average risk-adjusted underperformance of -3.1% a year

Tom Eckett

a group of white balls

Thematic ETFs shot the lights out last year, however, a recent academic study has warned the strategies “fail to create value” for investors looking to incorporate the latest megatrends in their portfolios.

The study of 526 specialised (thematic and sector) ETFs, entitledCompetition for attention in the ETF space, found these strategies deliver an average risk-adjusted underperformance of -3.1% a year after fees in the five years after they are brought to market.

But what is driving this significant underperformance? The academics argued thematic ETFs offering exposure to the latest trends in the market are launched by ETF issuers at the peak of excitement when the underlying holdings are at their most overvalued.

“In other words, it appears that ETF issuers cater to sentiment-driven demand for investment themes,” the study stressed.

While issuers will win in the short-term by attracting new investors to the ETF space with the lure of strong returns in exciting new themes, the long-term impact on sentiment towards the ecosystem could be more damaging.

“[Thematic] ETFs could encourage greater participation due to their marketing efforts,” the study continued.

The academics were quick to praise the Walmart-type broad-based ETFs that offer investors exposure to diversified portfolios at a low cost.

Overall, however, the report said: “This analysis suggests specialised ETFs do not create value for their investors by providing outperforming investment strategies. Consequently, the high fees and lack of diversification of these products remain a puzzle.”

This damning assessment of thematic ETFs, which are the subject of ETF Stream's next Big Call event on 31 March, comes at a time when investors are piling into these strategies with the asset class in Europe seeing a record €9.5bn inflows in 2020, according to data from Morningstar.

Despite the academic study’s concerning analysis, thematic strategies were among the best performing ETFs in Europe last year.

In particular, the iShares Global Clean Energy UCITS ETF (INRG) returned 136% over the 12 months while the WisdomTree Cloud Computing UCITS ETF (WCLD) and the Invesco Elwood Global Blockchain UCITS ETF (BCHN) soared 113% and 95%, respectively.

However, Kenneth Lamont, senior analyst, passive strategies research, Europe, at Morningstar, agreed investors should be wary about the stellar returns posted by thematic ETFs.

“Our own research has shown that thematic funds globally have struggled to survive and outperform global equity benchmarks over longer periods of time,” Lamont stressed.

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