First it was clean energy then artificial intelligence. Thematic ETFs offer exposure to structural long-term megatrends, however, timing the entry point is just as important as selecting the right theme.
BlackRock’s clean energy ETF provides a perfect example of this. While the iShares Global Clean Energy UCITS ETF (INRG) returned 17.6% annualised over the five years to the end of June 2023, the annualised return for investors – based on inflows and outflows – was -5.5%, a 23 percentage point (ppt) gap, according to Morningstar research.
This is an extreme example given the thematic ETF poster child saw $5.8bn inflows between November 2020 and January 2021, however, it highlights the challenge of not only selecting the right ETF but also choosing when to invest.
“Investor buying and selling habits connected with thematic funds over the last five years have destroyed considerable value,” Kenneth Lamont, senior fund analyst at Morningstar, warned.
“Fund investors are collectively poor market-timers and they particularly struggle in more volatile and exotic funds compared with more diversified core building blocks.”
This is especially pronounced for thematic ETFs which have more concentrated portfolios. In the search to offer the purest exposure to a particular megatrend, ETF issuers move down the market-cap spectrum, potentially leading to greater volatility.
“ETFs’ concentration results in high levels of volatility,” Lamont added. “More volatile funds seem to induce more frequent trading and a tendency to buy high and sell low. Most investors would achieve better investment outcomes by adopting a more patient buy-and-hold approach.”
As a result, demand for thematic ETFs has waned, with some investors concerned about the volatility and overlap with traditional sectors.
According to data from ETFbook, thematic ETFs have seen $116m outflows so far in 2024, as at 22 March, adding to the $1.1bn net redemptions seen last year.
This is in stark contrast to the combined $16.3bn inflows seen in 2021 and 2022 as investors rode the wave of the digital shift following the COVID-19 pandemic. Assets in thematic ETFs currently total $44bn, as at the end of 2023.
How thematic ETFs fit within a multi-asset portfolio is a challenge for fund selectors, with questions around whether they remain a satellite holding or can be incorporated as a core building block.
“Thematic ETFs will likely always be used as an extension to allocations in more traditional sectors, and normally only in higher risk portfolios, as opposed to being standalone allocations within our strategic asset allocation,” Terry McGivern, senior research analyst at AJ Bell, told ETF Stream.
“This is because there is often a high degree of overlap with traditional sector/ regional exposures and also because many of the newer themes do not have the data available to really work them into a normal capital market assumptions and asset allocation framework.”
Final word
Thematic ETFs can be a fantastic way to add alpha to portfolios, however, in a market where the number of products is booming, selecting the right ETF and adopting a long-term time horizon has never been more vital.
This article first appeared in ETF Insider, ETF Stream's monthly ETF magazine for professional investors in Europe. To read the full edition, click here.
