Thematic funds: winners, losers and the importance of timing
In the latest monthly article, a Morningstar analyst explains how the returns from funds investing in a theme can hugely vary.
22nd March 2024 09:15
by Kenneth Lamont from Morningstar Research
Thematic funds have risen in prominence globally since the Covid-19 pandemic, grabbing headlines and growing market share, but the cyclical volatility of themes means picking the right theme at the right time is crucial to investment success.
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Thematic funds attempt to harness secular growth themes ranging from demographic shifts to the rise of artificial intelligence (AI) and big data. Some have delivered bursts of eye-catching performance, while others have failed to gain traction.
Measuring theme returns
In the table below we have collected the annual returns of all the investment themes we track. Theme performance here is proxied by tracking the returns of the median fund tracking a given theme over the year.
| Return (%) | |||||
| Theme | 2019 | 2020 | 2021 | 2022 | 2023 |
| Artificial Intelligence + Big Data | 29.6 | 52.5 | 10.8 | -38.7 | 45.2 |
| Battery Technology | -0.2 | 94.6 | 16.4 | -31.1 | -31.0 |
| Broad Thematic | 28.3 | 26.2 | 13.9 | -26.7 | 17.3 |
| Cannabis | -23.9 | 22.1 | -21.8 | -66.0 | -12.4 |
| Cloud Computing | 29.5 | 62.2 | 6.4 | -41.5 | 42.1 |
| Consumer | 24.6 | 29.5 | 4.6 | -26.8 | 15.8 |
| Cyber Security | 29.6 | 50.2 | 10.3 | -40.5 | 44.0 |
| Demographics | 22.5 | 13.8 | 13.0 | -21.1 | 13.3 |
| Digital Economy | 27.3 | 52.6 | 4.5 | -37.6 | 32.0 |
| Energy Transition | 30.4 | 51.9 | 9.2 | -21.3 | 4.6 |
| Fintech | 34.4 | 35.5 | 1.8 | -35.6 | 22.7 |
| Food | 19.2 | 12.7 | 8.8 | -20.3 | -0.8 |
| Future Mobility | 27.8 | 58.5 | 17.8 | -33.4 | 13.9 |
| Life Sciences | 27.7 | 36.6 | -3.0 | -28.0 | 1.4 |
| Logistics + Transportation | 14.3 | 9.0 | 22.2 | -6.6 | 24.8 |
| Multiple Physical World Themes | 25.7 | 24.2 | 18.4 | -22.7 | 9.1 |
| Multiple Social Themes | 20.2 | 10.9 | 15.5 | -17.2 | 18.0 |
| Multiple Tech Themes | 32.5 | 50.9 | 9.2 | -37.1 | 32.2 |
| Nano Technology + New Materials | 16.7 | 30.2 | 16.5 | -26.6 | -13.1 |
| Political | 29.9 | 17.0 | 11.6 | -31.2 | 17.7 |
| Post-Corona | 16.3 | 26.8 | 12.7 | -26.9 | 8.0 |
| Resource Management | - | - | 3.4 | -23.8 | 25.4 |
| Robotics + Automation | 30.6 | 18.6 | 23.8 | -22.5 | 16.1 |
| Security | 34.9 | 44.8 | 15.6 | -33.4 | 27.5 |
| Space | 29.3 | 36.5 | 10.8 | -33.4 | 28.2 |
| Virtual Reality and Gaming | 37.2 | 11.7 | 10.0 | -34.2 | 16.1 |
| Wellness | 19.8 | 70.6 | -1.9 | -36.9 | 25.0 |
One of the pleasing features of thematic investing is that global events can often be linked directly to theme performance and we can certainly see that in the table.
AI takes the top spot
2023 may well be looked back on as the year AI went mainstream. It was the year AI technology burst into the daily lives of billions for the first time and forced its way to the top of the agenda at the world's most powerful corporations and governments. This was reflected in the stellar performance achieved by the AI and big data theme, which returned 45% over the year.
Companies deemed to have exposure to theme were rewarded with outsized returns. In particular the “Magnificent Seven” dominated market returns, which played out well for AI funds. Six of those seven stocks appear in 10 most common holdings of AI and big data funds.
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The boom in AI can also help explain the performance of both cybersecurity and cloud computing, which both have a significant overlap with the AI and big data theme and each also returned over 40% in the year. For example, Microsoft Corp (NASDAQ:MSFT), Alphabet Inc Class A (NASDAQ:GOOGL) and ServiceNow Inc (NYSE:NOW) each appear in the top 10 most-common holdings of both AI and big data funds and cloud computing funds.
Battery tech stumbles
The battery technology theme was the worst performer of 2023 with a 31% loss. The theme suffered in the face of slowing demand from China and an oversupply of key inputs such as lithium.
The 76% performance gap between AI and big data and battery tech themes emphasises the importance of picking the right theme.
Right theme, wrong time?
The poor year for the battery theme sits in contrast to its stellar performance in 2020, when, as the best-performing theme it returned over 90%. This riches-to-rags story highlights how cyclically volatile thematic funds can be, and demonstrates the importance of timing in a thematic investment.
One of the most striking features of the table above is how poorly thematic funds collectively did in 2022, with not a single theme registering a positive return. This herd-like performance versus the broader market can be explained by thematic funds in-built growth and tech tilts. This provides insight into why they performed so well in the frothy, tech-led post-Covid recovery and suffered so much in the preceding “tech reckoning”. This market element muddies the waters still further when timing is considered. Not only does an investor have to predict the timing of cycles unique to the theme itself, but also has to contend with making broader market growth/value timing decisions too.
Timing is hard
When investing in a thematic fund, investors are making a trifecta bet, wagering that they can pick the right fund, tracking the right theme at the right time. Each of those individual bets has a wide range of outcomes, and getting only one of the three wrong can still leave an investor nursing losses.
Our own previous research has shown that investors are poor market timers, frequently buying and selling at the wrong times and that most are better off buying and holding over longer periods. This has never been truer than for thematic funds whose cyclical volatility magnifies bad timing decisions and underlines the importance of investing over longer periods.
Kenneth Lamont is a senior analyst at Morningstar.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.