Investors are moving away from exchange-traded funds (ETFs) tied to specific themes such as artificial intelligence and video games, and pouring into funds linked to the large-cap benchmark indexes of the US stock market, which are hitting historical highs. However, if the overall market declines, the pace of investor withdrawals may slow down. According to financial data and analysis company Morningstar, despite the continued increase in overall fund inflows for stock ETFs, thematic ETFs investing in various companies ranging from solar energy to robots and millennial consumers have seen net outflows for the third consecutive year.

Morningstar data shows that hedge funds with total assets of $108 billion have already lost $5.8 billion of investor capital this year, more than the $4.8 billion for the entire year of 2023. Taylor Krystkowiak, investment strategist at asset management company Themes etf focusing on thematic ETFs, said: "Thematic ETFs are going through a winter now."

This year, the returns on broad market indices have set a higher standard for thematic funds. Driven by influential stocks like Nvidia (NVDA.US) and Meta (META.US), the S&P 500 index has risen by over 22% year to date. The five largest ETFs tracking the S&P 500 Index and the Nasdaq 100 Index have attracted inflows of $170 billion this year. The SPDR S&P 500 ETF Trust last Thursday became the first ETF with assets under management reaching $600 billion.

"It's not that people no longer like the concept of themes, but in a bull market dominated by a few large-cap stocks, it's difficult for any theme to stand out," said Aniket Ullal, ETF analyst at market research company CFRA.

Challenges in thematic investing

Morningstar siasun robot&automation analyst Bryan Armour said that part of the challenge lies in the nature of thematic investment itself. A Morningstar study found that investors often mistimed their investment in thematic ETFs. The study found that investors in thematic ETFs lost two-thirds of their returns over a five-year period.

Armour said: "You have to choose the right theme, then make sure the fund selects stocks that benefit the most from that theme, and then correctly time the purchase of the fund. Doing these three things is difficult."

Even some holding the market favorite Nvidia with a high AI thematic ETF find it challenging to retain assets. According to the company, over the past 12 months, the Global X Robotics & Artificial Intelligence ETF had a net outflow of $89 million. Despite nearly 13% of the fund's portfolio being this AI chip manufacturer - almost twice the weight of Nvidia in the S&P 500 index - its performance only matched that index, with both funds rising by about 39% in the past year.

Global X thematic investment director Arelis Agosto said: "We still have long-term confidence in thematic funds. We have a long-term view." Over the past 12 months, 19 out of the company's 31 thematic funds experienced outflows.

According to Morningstar data, Cathy Wood's ARK Innovation ETF, which invests in companies expected to achieve "disruptive innovation," saw the highest outflow of funds among all thematic ETFs in 2024 with $2.6 billion. The fund has dropped over 9% this year.

Thematic funds often charge higher fees, a fact that may reduce their attractiveness. The average fee for thematic ETFs is 0.62% of the investment amount, while ETFs average 0.49%. Morningstar data shows that investors incur fees of 0.09% holding the Vanguard S&P 500 ETF, and 0.03% holding the Blackrock iShares Core S&P 500 ETF.

According to Morningstar data, the number of thematic funds issued this year has decreased from 39 in 2023 to 13, while the number of closed thematic funds in 2024 has exceeded the total for 2023, reaching 36, compared to 32 in 2023.

However, thematic ETFs have been on the rise recently, launching 18 products since December last year, including the Transatlantic Defense ETF investing in NATO defense companies, and the European luxury goods ETF holding shares of Ferrari and the Swiss watch group.

Krystkowiak said, "I believe the focus will shift back to thematic etfs when the performance of the s&p 500 index large caps is no longer as strong as it is today."

Editor/rice