Beware when investing in a theme

You need a few things to go right to be successful, if the fund survives

Ian Tam, CFA 29 April, 2020 | 12:23AM

 

 

Ian Tam: Over the last few years, you may have noticed several seemingly innovative and new funds and ETFs come to market that revolves around a very specific theme. For example, funds that invest in the ageing baby boomer demographic, funds that invest in Big Data, artificial intelligence or even funds that invest solely on video games and e-sports. At Morningstar, we define these as thematic funds. These themes tend to invest in areas that pertain to macroeconomic or structural trends which transcend the traditional business cycle. Globally, Morningstar has found just over 300 of these types of funds with the majority of them domiciled in Europe.

If you have a look at this first chart, you'll see that in 2019, Morningstar estimated that there was close to US$200 billion invested amongst thematic funds globally which is a relatively small number compared to total assets but with an undeniable growth rate. This said, are they resilient?

So, the second chart, which you'll see on the screen here, shows the mortality rate of thematic funds. So, in other words, how many of these types of funds have been liquidated or shut down over time. So, over a one-year period, 90% of these types of funds survived; after five years, 60% survived; but after 15 years, only 10% of thematic funds remained. The black line on the chart shows the success rate of the funds or what percentage of the surviving funds outperformed the MSCI World Index. Surviving funds tend to have a higher success rate which should be intuitive because performance is often a determining factor for a fund's survival.

Investors must be cautious when investing in thematic funds, because in effect, you're placing three different bets. The first bet is that you are picking the right theme. Second bet is that you're picking the best fund that subscribes to that theme. And the third best is betting that the market has not already priced in the potential of that theme. So, the odds of winning all three bets is going to be low, but the payoff can be significant.

More information about thematic funds can be found in Morningstar's landscape report available in the link at the bottom of this video transcript.

For Morningstar, I'm Ian Tam.

Learn More About Thematic Funds

Explore the Global Thematic Fund Landscape

About Author

Ian Tam, CFA  Iam Tam, CFA, is Director of Investment Research at Morningstar Canada.