The downsides of thematic funds
- Robin Powell
- Apr 22, 2024
- 3 min read
Thematic funds have become very popular in recent years, especially with the rise of sectors like AI, clean energy and biotechnology.
These funds aim to capture big opportunities by focusing on a specific trend or sector. But how suitable are they for long-term investors? And are the stories they tell always matched by strong returns?
In this short video, JEFFREY PTAK from Morningstar cuts through the hype and explains why thematic funds may not be as straightforward, or rewarding, as they seem.
From the timing of fund launches to the way these products are marketed, there are important questions everyone should ask before investing.
KEY TAKEAWAYS
1. Thematic funds are narrow and risky
They often focus on a small segment of the market, which limits diversification and increases volatility.
2. Most are launched after strong performance
By the time investors get in, prices are often already high, making it harder to earn strong returns.
3. They’re usually sold with a story
Thematic funds are marketed with compelling narratives, but these don’t always align with long-term investment success.
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TRANSCRIPT
Robin Powell: A phrase you may have seen or heard lately is thematic investing. Thematic funds offer investors exposure to investment “themes” such as biotechnology or artificial intelligence.
So should you consider investing in one? The first thing you need to realise is that thematic funds are considerably more risky than, say, broad-market index funds.
Jeffrey Ptak: What you're talking about are very narrow slices of the market, and the themes can take different forms. It could be it could be the theme, could be artificial intelligence, it could be innovation, it could be a medical breakthrough, it could be something that has more of a political bed to it, you know? But in each one of these cases, you're taking a slice of the market that represents companies that conform to the theme that you have defined and the attributes that make it up.
RP: You also need to remember that thematic funds tend to be launched after a period of strong performance by that particular theme.
So, by the time you start investing, the stocks within that fund may already be expensive.
JP: Are they more often in the value column of the style box, the core column or the growth column of the style box?
And what you find is when you look at these thematics, around three quarters of them are in the growth column of the style box. What does that mean? It means that they're growing, but it also means that they are not inexpensive. These tend to be pricey stocks explaining why these funds so often are plotted in that growth column of the style box, according to quite a bit of price risk.
RP: The final thing to realise is that thematic funds tend to be very heavily promoted. Why?
Because investors are influenced by stories, and thematic funds almost always come with a compelling narrative.
So fund providers like them, and so does the financial media.
JP: We've all heard of story stocks in a sense. These are story funds. You know, it's, it's, it's an easier sell when you can package up a set of securities, you know, slap an ETF name on it and go out to the market and say, you want a piece of this action, you know, you want to get on this train.
RP: In short, thematic funds are effectively concentrated bets. Of course, you might be lucky and get in and out at the right time.
But the evidence tells us that most thematic investors tend to buy and sell at the wrong time.
So, exercise caution. Great stories rarely make for great investments.
© The Evidence-Based Investor MMXXV.
