Thematic ETF Investing Erodes Returns, Study Says

Buying high meant investors reaped only one-third of the funds’ returns during a five-year period, according to a new Morningstar report.

Reviewed by: Staff
Edited by: Mark Nacinovich

Investors lost out on much of their potential returns from thematic ETFs and mutual funds because of bad timing, according to a new report from Morningstar. 

Thematic funds attracted hype and flows from investors who bought high, the report from Wednesday said.  

Thematic funds averaged a 7.3% annualized total return in the five-year period ended June 30, 2023. Those returns, however, dropped by 4.9 percentage points on an asset-weighted basis, meaning that investors in those funds saw only about one-third of the returns. The average gap for all stock funds was only 0.5% during the same period. 

The report adds to evidence from Morningstar’s previous studies on asset-weighted returns, a series of papers entitled “Mind the Gap.” The authors of the November report, Kenneth Lamont and Matias Möttölä, contend that this shows that fund investors are bad at timing the market. Additional data on thematic funds indicates that the gap was exacerbated by more concentrated or unusual funds. 

“Our findings show that, in aggregate, investor buying and selling habits connected with thematic funds over the last five years have destroyed considerable value,” the report stated.  

Wider ETF ‘Return Gaps’ 

While thematic funds as a whole had substantial return gaps, the gaps weren’t evenly distributed. Traditional mutual funds had significantly smaller return gaps than ETFs did. That was especially true for tech-themed funds where ETFs had a return gap that was five to six points higher than the return gap for mutual funds. That was because thematic ETFs tended to be more concentrated and used as tools for making tactical investing bets.  

Different themes also had different-sized returns gaps. The largest were funds centered on the transition from fossil fuels to clean energy. That category of thematic funds had a return gap of 11.9%. For funds that returned an annual average of 14%, the average investor saw a return of just 2.1%.  

iShares' ICLN  

The report cited the iShares Global Clean Energy ETF (ICLN) as an example of how investors lose out. The index it tracks posted an annualized return of 17.6% over the five years studied, but the annualized return for investors who bought the fund was -5.5%, a chasm of over 23 points. 

The report shows that investors poured nearly $6 billion into the fund from November 2020 to January 2021, when Joe Biden was elected president. The inflows in those three months were more than every other month in the period examined combined. That means all those investments didn’t benefit from the rise leading up to that point and experienced the 40% drop over the next few years.  

The report also cited the ARK Innovation ETF (ARKK) as an example of investors buying high on a fund. 

“More volatile funds seem to induce more frequent trading and a tendency to buy high and sell low,” the report stated. “Most investors would achieve better investment outcomes by adopting a more patient buy-and-hold approach.” 

Contact Gabe Alpert at [email protected]. 

Gabe Alpert is a former data reporter at with over seven years’ experience in financial journalism. He also previously contributed reporting and analysis to Barron’s Magazine, Investopedia and other publications.