Investors flee thematic ETFs as stock benchmarks soar

Investors are leaving exchange-traded funds tied to specific themes, such as artificial intelligence and video gaming, as they flock to funds linked to broad stock-market benchmarks that are hitting record highs. The run for the exits, however, may slow if the broader market stumbles.

While flows in equity ETFs overall continue to climb, thematic ETFs, which invest in companies tied to everything from solar energy to robotics and millennial consumers, are on pace for their third-consecutive year of net outflows, according to financial data and analysis company Morningstar.

The category, which has total assets of $108 billion, has lost $5.8 billion in investor capital this year, greater outflows than the $4.8 billion for all of 2023, according to Morningstar.

“It’s winter for thematic ETFs right now,” said Taylor Krystkowiak, investment strategist at Themes ETFs, an asset-management firm focused on this category. Returns from broad market indexes are setting a higher bar for thematic funds this year. The S&P 500, the benchmark for the U.S. stock market, has climbed over 22% this year, propelled by gains from influential stocks including Nvidia and Meta Platforms.

The five-largest ETFs tracking the S&P 500 and the Nasdaq 100, another equity benchmark, have seen inflows of $170 billion this year. The SPDR S&P 500 ETF Trust on Thursday became the first ETF to reach $600 billion in assets.

“It’s not that people don’t like the idea of themes any longer, but that a bull market dominated by a handful of megacaps makes it hard for any theme to stand out,” said Aniket Ullal, ETF analyst at CFRA, a market-research firm.

Bad timing

Part of the challenge, said Bryan Armour, ETF analyst at Morningstar, is the nature of thematic investing itself.

Investors often mistime investing in themes, according to a Morningstar study that found investors in thematic ETFs missed out on two-thirds of their returns in a five-year period.

“You have to pick the right theme, then be sure that the fund has picked the stocks that will benefit most from that theme, and then be right about the timing of when you buy the fund,” Armour said. “Getting that trifecta right is tough.”

Even some AI-themed ETFs with outsized exposure to market-darling Nvidia have struggled to retain assets. The Global X Robotics & Artificial Intelligence ETF has seen net outflows of $89 million in the last 12 months, according to the firm. Despite the fund having nearly 13% of its portfolio in the AI chipmaker–almost double the S&P 500 weighting–it has performed only in line with the index, with both up about 39% in the past year.

“We still have longer-term conviction in themes,” said Arelis Agosto, head of thematics at Global X, which has seen outflows in 19 of its 31 thematic funds over the last 12 months. “We take a long-term view.”

Cathie Wood’s ARK Innovation ETF, which invests in companies promising “disruptive innovation,” has seen $2.6 billion in outflows in 2024, the most of the thematic ETFs, according to Morningstar. The fund is down more than 9% this year. The fact that thematic funds tend to levy higher fees can diminish their appeal. Thematic ETFs’ fees average 0.62% of money invested while the average ETF fee is 0.49%. Investors pay 0.09% to own the State Street S&P 500 ETF and 0.03% for BlackRock’s iShares Core S&P 500 ETF, according to Morningstar. The number of thematic launches dropped to 13 this year from 39 in 2023, while closures of thematic funds in 2024 have already topped 2023’s total, with 36 compared to 32, according to Morningstar.

Themes ETFs is bucking that trend, having launched 18 products since December, including a Transatlantic Defense ETF , which invests in defense companies based in NATO member states, and a European Luxury ETF, with holdings in Ferrari NV and Watches of Switzerland Group PLC .

“I think that when S&P 500 megacaps stop delivering the way they do today, the focus will shift back to thematic ETFs,” Mr. Krystkowiak said.