Thematic ETF boom still going strong despite brutal year

Thematic ETF boom still going strong despite brutal year

Thematic investing can be traced back as far as 1948 when a mutual fund called the Television Fund was launched. And if it lasted that long, it could survive the ravages of a year with inflation — at least as far as advocates like Kenneth Lamont are concerned.

Aggressive interest rate hikes by central banks as they battle rising prices have been brutal for thematic ETFs, a group of funds that target investments based on trends such as robotics or electric cars. Rising borrowing costs have hammered these riskier, speculative bets.

Still, Lamont, a nine-year veteran at Morningstar UK Ltd., sees reason for optimism. Even with an average drawdown of 30% for U.S. thematic ETFs in 2022 — nearly double the losses of the S&P 500 — outflows are less than 1% of the $115 billion in assets under management, data compiled by Bloomberg Intelligence show. It shows continued confidence in one of the hottest areas of investing that has helped power record launches and growth for the $6 trillion ETF industry.

“It’s almost unbelievable how little the net outflow has been,” Lamont, Morningstar’s senior manager research analyst, said by phone. “If it was really used trendy, we would have expected to see some sort of rush for the door.”

To date, 53% of thematic funds have been underwater since their inception. Launches in 2022 slowed to 38 from the 77 seen in the previous year, while closings rose to 20 from five, data compiled by Bloomberg Intelligence showed.

All the while, investors have been holding on. Most famously, Cathie Wood’s bellwether ARK Innovation ETF added cash even as its price fell 63% this year.

“From the demand side to these funds, the genie is out of the bottle,” Lamont said. “Thematic investing is compelling. We are narrative creatures and every fund and investment style has a built-in narrative.”

More broadly, as of Dec. 7, firms have launched 422 new ETFs this year, five more than the number seen over the same period in 2021. This total puts 2022 on track to surpass last year’s record for debuts, even amid recent market turmoil across asset classes.

Among thematic funds, innovation and emerging markets technology were the top themes driving year-to-date inflows to $2.2 billion and $1.8 billion respectively. Technology and communications had the most outflows with $3.2 billion leaving such funds, followed by cloud computing at $1.2 billion and robotics and artificial intelligence at $941 million.

The flight of money may not come as much of a surprise as the tech sector has faced multiple headwinds this year. Companies including Twitter Inc., Meta Platforms Inc. and Inc., have cut their workforces by the thousands while other firms have cut staff and slowed hiring as they grapple with higher interest rates and a pullback in consumer spending.

The backdrop for stocks remains challenged for the year ahead as concerns about the impact of Fed policy on growth and corporate earnings run rampant. To Athanasios Psarofagis, a Bloomberg Intelligence ETF analyst, this suggests tougher times ahead in the thematic space.

“There’s probably going to be a purge,” he said by phone. “The market is going to be tougher going forward, there’s just no way it’s going to be able to support it.”

Issuers are unlikely to give up without a fight. Thematic ETFs charge a higher expense ratio of about 50 basis points compared to the average ETF, according to data by Bloomberg Intelligence — a compelling reason to keep them traded and even to start more.

Still, Sylvia Jablonski, chief investment officer at Defiance ETFs, is bullish on the space. Investor conviction will be enough to support these funds, she said, most of which revolve around innovation, digitization, artificial intelligence and advances in computing.

“As markets evolve and new themes become investable, investors are more comfortable with diversifying innovation into a basket, versus banking on one name,” she said. “There has been so much progress in classic sectors such as energy, technology, communications, pharmaceuticals, alternative energy and this has opened the doors for issuers with good ideas.”

–With help from Sam Potter.

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