The dismal results of thematic investing


Thematic investing is a form of investing which focuses on long term trends/megatrends instead of specific sectors/companies. Some examples of such mega-trends could be innovation, clean power, smart mobility etc. In the recent years, thematic investing has become more and more popular and has tripled their share of the global investment market to 2.7 per cent of all equity funds in the past decade.


The most famous thematic fund which you might have heard of is the ARK ETFs. In fact, ARK Innovation Fund (ARKK) is probably the largest/one of the largest thematic ETF. Most of us should have heard of these ETFs. I have written about these ETFs quite a number of times in my blog. In fact, I continue to hold some of these ETFs in my portfolio. For those who have been regular readers, you could have already noticed the "crazy" downtrend the ARKK ETF has been with 9 out of the most recent 10 months in the reds. Since Oct 2021, ARKK ETF has lost two-third of its share price. In comparison, NASDAQ has shed less than one-third of its value in the same time period.


ARK ETFs are just some examples of thematic funds. It's probably not fair to associate all thematic funds with ARK ETFs and deem that they all have dismal results.


To give a more complete overview, let's take a look at the table below.


(Source: https://www.ssga.com/library-content/pdfs/etf/us/thematic-next-generation-trends-etf-dashboard.pdf)


Here is a list of some thematic Next-Generation Trends ETF. You can see the various mega trends these ETFs focus on from the list. There are clean power, smart mobility, innovative technology etc. Many of them do not have results for 5 years and more as many thematic funds only come into existence in the recent years.


In fact, global thematic funds under management have only soared in the recent years as shown below.


(Source: https://www.ft.com/content/1db0f968-2175-4434-ba65-c57632b51e02)


Now, back to the table above. If you noticed, most of the ETFs on the table do not actually beat SPY on an annualised basis by any measure. The only ETF which beats SPY is SDPR S&P Kensho Clean Power ETF (an ETF which focus on companies whose products and services are driving innovation behind clean energy sector). However, I am doubtful if this outperformance will sustain. We all know how much the energy sector has grown in the past 2 years. I won't be surprised that a reversion to mean will happen soon.


In case you are wondering, the ARKK didn't beat SPY on annualised returns over 1 year, 3 year or 5 year too.


If we take all the thematic funds and compare them against the index, you will also find that only 39% of the thematic funds beat the index over a 5 year period. When you extend the period to 15 years, you will realise more than three quarters of thematic funds have closed. Only one in ten survived and outperformed- which brings us to a poor statistics of just 10%.


So why do thematic funds perform so badly?


Some arguments in the town are that thematic funds are usually created near or at the peak of the bull market when euphoria is high. Investors feel positive about the market during bull runs and are very inclined to invest in funds which resonate with future trends which are usually associated with even larger returns. Most of the times, the market went on to be on the downtrend after the peak of the bull market and hence these thematic funds end up being poor performers. Unfortunately, ARK ETFs are currently the perfect textbook examples for this.


Given all that is written here, am I going to start dumping all the ARK constituents in my portfolio? No, I'm not going to do so. However, I have reduced my exposure to the ARK ETFs since the beginning of the year when I highlighted what are the changes I am making to my portfolio. I am still keeping them due to two reasons. One, I still believe in the long term performances of these ETFs. If the inflation issue is sorted out in a year, I believe the ARK ETFs will outperform the index. Two, these ARK ETFs provide low correlation in relation with some of my other constituents (eg. BRK.B) in the portfolio and hence help in providing the balance needed (though the recent strong correlation they have with Bitcoin are getting me worried).


Do you believe in thematic investing? Join the community in my Telegram channel. I will create a poll on this and you can contribute to it too!


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