A Closer Look at the Growing Allure of Thematic ETFs
The eclectic category of concentrated themes is anything but boring.
As innovation sweeps across the ETF industry, thematic strategies that concentrate on specific trends or investing patterns are being rolled out in all shapes and sizes.
With the devil residing in the details, comparing individual fund performance to that of broad market indexes may mislead investors.
According to etf.com data, 316 exchange-traded funds invest in themes from infrastructure to cybersecurity, which combine for $132 billion and have an average expense ratio of 61 basis points. But that total asset figure is a bit deceiving because thematic ETFs are essentially trading vehicles, which means the money can move fast and the performance ride can be unruly.
The largest thematic fund in the etf.com database is the $8.8 billion Global X U.S. Infrastructure Development ETF (PAVE), which is up 2.4% this year and 15% over the past 12 months.
If domestic infrastructure is your preferred bet, you might be happy with that return for the cost of 47 basis points in expenses.
But if that performance is stacked against something much broader, such as the Vanguard S&P 500 ETF (VOO), some investor grumbling would be understandable.
VOO, which charges just 3 basis points and is being carried through market-capitalization weighting by some of the hottest-performing companies in the market, is up 3.4% this year and 22% over the past 12 months.
Thematic ETFs vs. Index Funds
Of course, an easy click of the mouse can uncover thematic ETFs that are blowing the doors off big, lazy, indexed strategies, cap-weighted or not.
The Direxion Daily Dow Jones Internet Bull 3X Shares ETF (WEBL) is up 15% this year and 81% over the past 12 months.
Mind you, that 3X in the name represents leverage and should be a red flag to any investor who plans to hold it for more than a few days because leverage can be brutal when the trade moves in the opposite direction.
Skipping down the list past the top-performing leveraged strategies, there is the long-only Themes Generative Artificial Intelligence ETF (WISE), which tracks an index of about 40 stocks that derive revenues from AI-related business.WISE is up 2% this year and 33% over the past 12 months.
The point is that thematic investing is a mixed bag, categorized as strategies making concentrated bets. That was driven home in a report by Morningstar comparing the broad category performance to that of the S&P 500 and a 2050 target-date fund.
Hopefully, it won’t surprise anyone to learn that large, diversified and low-cost indexes outperform a collection of strategies that represent an eclectic mix of aggressive market bets.
According to Morningstar, over the three years through November 2024, the S&P 500 produced an annualized return of 11%, the 2050 target-date fund averaged 7% and thematic funds averaged a 1% annual loss.
The takeaway from such an analysis is along the lines of slow and steady wins the race, boring is better, and so on.
But we all know it’s not a fair comparison to measure the performance characteristics of things that aren’t designed to compete with one another.
There’s a reason nobody has yet come up with an ETF tracking an index of all the thematic strategies. It would be a convoluted mess of underlying bets canceling each other out and occasionally driving performance to the moon and back into the dirt.
On second thought, maybe that would be a fun index to monitor. But not something I’d invest in.
