Investors are notorious for making poor market timing decisions, and a recent report by Morningstar reveals that their behavior is even worse when it comes to theme funds.
During a five-year period ending on June 30, the average investor lost over two thirds of their total returns due to unfortunate timing. While thematic funds boasted an average annual return of 7.3%, investors only earned a meager 2.4% return when accounting for cash inflows and outflows.
This discrepancy between actual returns and fund returns is primarily due to investors entering the market after significant gains have already been made and exiting too late. It's a classic behavioral trap of buying high and selling low, rather than the inverse.
Thematic funds focus on specific niches within sectors or across various industries like artificial intelligence, clean energy, or aging populations. While these funds have the potential for strong performance, they often come with significant volatility.
Notably, Morningstar discovered that more volatile funds result in more frequent trading and a tendency for investors to buy high and sell low.
Furthermore, Morningstar found that the narrower the focus of a fund, the larger the gap between total returns and investor returns. This return disparity was also more pronounced in thematic ETFs compared to thematic mutual funds.
Thematic Funds: A Risky Bet for Investors
Thematic funds have experienced a surge in popularity since the onset of the COVID-19 pandemic. These funds, offered by major ETF sponsors such as BlackRock's iShares, Invesco, and Fidelity Investments, have more than doubled their assets under management globally since 2018, according to Morningstar.
However, while thematic funds may seem appealing, they come with their fair share of risks. According to Lamont, a prominent investment expert, the volatile nature of these funds "plays to the worst instincts of certain investors—gambling instincts."
Morningstar's analysis reveals that although thematic funds as a whole had a negative investment gap, some themes fared worse than others. The energy transition theme, in particular, had the largest gap at 11.9%. This means that while the average energy transition fund returned 14% over a given period, investors only gained a mere 2.1% on their invested dollars during the same timeframe. As Lamont puts it, this is "an astonishingly poor result for investors."
Another notable example is the iShares Global Clean Energy ETF (ICLN). While the index tracked by this ETF saw an annualized return of 17.6% over the past five years, investors who purchased the fund during the same period experienced an annualized return of -5.5%. This translated into a significant investment gap of 23% between what the fund returned and what investors actually received.
The lesson to be learned from these findings is clear—poor investor behavior often hinders performance and can be financially detrimental. As enticing as thematic funds may be, it is crucial for investors to approach them with caution and be mindful of their own behavioral biases.
In conclusion, thematic funds may offer unique investment opportunities, but the potential risks should not be overlooked. The key is to remain vigilant and avoid succumbing to impulsive decision-making.
