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Bad Timing Drained Returns for Thematic Fund Investors: Morningstar

By Dinah Wisenberg Brin

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What You Need to Know

  • Investments in specific strategies have more than doubled in assets under management globally since 2018.
  • A buy-and-hold approach would have offered better results for most, the study found.
  • More volatile funds seem to induce more frequent trading and a tendency to buy high and sell low.

Poorly timed trades caused investors in thematic funds to miss two-thirds of the returns in those vehicles, a recent Morningstar study found.

Investors in thematic funds earned on average only 2.4% a year over the five years through June 30, well short of thematic funds’ overall 7.3% average total return annualized, according to “The Big Shortfall.”

This meant that investors experienced a 4.9-percentage-point annual return shortfall due to  mistimed purchases and sales, according to Morningstar.

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

Thematic funds, which invest in particular strategies, such as artificial intelligence or aging populations, have more than doubled in assets under management globally since 2018 and sparked questions about how investors use them, Morningstar noted.

Global thematic fund AUM, excluding China, more than doubled to $632.4 billion in September this year from $262.3 billion in Sept. 2018, according to Morningstar.

They saw a far greater gap in investor versus fund returns than non-thematic funds, according to the study, which found an only 0.5% gap in investor returns compared with returns for all equity funds in the same five years.

“The narrative-driven investment style and prominence on retail brokerage platforms make thematic funds particularly attractive to portions of the retail investment community. The volatile return profiles of many thematic funds, coupled with low- or no-commission trading and the intraday trading capabilities of thematic ETFs, can encourage the worst type of investor behavior and ultimately result in poor investment outcomes,” the report’s authors wrote.

“The results support previous findings … that fund investors are collectively poor market-timers and they particularly struggle in more volatile and exotic funds compared with more diversified core building blocks,” they said.

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

Investors lost more value — over 500 basis points — in focused funds like those tracking technology and “physical world” themes (those centered on managing physical resources, such as alternative energy funds) than in more diversified, broad thematic peers, Morningstar researchers found.

And return gaps were far wider in thematic exchange-traded funds than in thematic traditional mutual funds, the report said. ”ETFs tend to offer more concentrated bets and lend themselves to tactical usage.”

The largest return shortfalls occurred in highly targeted funds that “posted eye-catching performance, attracting large net inflows before suffering a change of fortune,” Morningstar said.

Image: Adobe Stock

Dinah Wisenberg Brin

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