Interactive Investor

Thematic strategies deflate after fund launch gold rush

26th July 2022 11:32

Sam Benstead from interactive investor

Buying the flavour of the month is a proven way to lose money, Sam Benstead reveals. 

Chasing hot investment themes has been a losing strategy this year, with eight out of 25 of the worst-performing funds so far in 2022 year considered “thematic” funds.

Thematic funds own a basket of stocks whose fortunes are tied to a specific theme. They can be actively managed or track a basket of stocks based via an exchange-traded fund (ETF).

This year, the worst performers invested in digital assets, online retail, sports betting, cannabis, innovation, technology, software and 5G connectivity. Six out of eight of these funds were launched after 2020.

The worst-performing active funds this year to 21 July are HAN ETC Group Digital Assets & Blockchain Equity UCITS ETF, with a 55% drop, followed by a 54% fall for HAN Global Online Retail ETF (LSE:IBUY) and a 43% drop for Nikko AM ARK Disruptive Innovation ETF.

The poor performance can be attributed to two factors: rising interest rates crushing fast-growing but expensive stocks, where thematic funds tend to invest, and thematic funds launching only once a theme has had its time in the sun and is due a fall.

Morningstar, the fund data group, said money poured into thematic funds last year, with 589 new thematic funds debuted globally in 2021, more than double the previous record of 271 fund launches in 2020.

At the end of December 2021, Morningstar had 1,952 thematic funds in its database, with $806 billion (£675 billion) invested.

Technology themes were the most popular, accounting for half of thematic funds and half of inflows last year. Energy transition was also a popular area, with around $100 billion invested.

Such funds got a huge boost in late 2020 when newly elected US president Joe Biden pledged billions of dollars of government support for green infrastructure, according to Morningstar.

In total, 72% of thematic funds exhibit a growth bias compared with just 6% with a value tilt. This shouldn't be a surprise, as most thematic funds are seeking to tap emerging themes with large growth potential, such as technology, as Morningstar points out.

Therefore, in the face of rising interest rates to quell inflation, thematic funds have performed poorly this year. Higher interest rates decrease the appeal of stocks that promise high profits in the future as investors can get a better return from their money today.

Leaving aside the tricky macroeconomic environment, thematic funds still tend to fail. Morningstar found that in the 10 years to the end of 2021, nearly 60% of US thematic funds available to American investors shuttered, and just 22% both survived and outperformed global stocks.

Over the past 15 years, more than three-quarters of thematic funds globally have shuttered and just one in 10 survived and outperformed.

Morningstar said: “Thematic funds have captured investors' imagination, but buyers should beware. They are often designed more with saleability in mind than suitability. Many cross the border into gimmick territory.

“Historically, thematic fund launches have tended to move in cycles. New strategies are often introduced in periods of strong performance, like the new millennium and the mid-2000s. But they tend to wane during downturns.”

This makes thematic fund launches a bull-market phenomenon, and the last couple of years have been no exception.

“The second half of 2020 witnessed nearly as many launches as the entirety of 2019, and 2021 was another record year with 90 new launches. Nearly half of these new launches came to market in the fourth quarter of 2021,” Morningstar noted.

One thematic fund is endorsed by interactive investor: iShares Global Clean Energy ETF USD Dist GBP (LSE:INRG). It has been a member of the ACE 40 rated ethical investments list since launch in October 2019, as a low-cost option within the specialist low-cost category.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.