The investor experience with thematic funds
They say (no: I say) ETF picking is the new stock picking. And as with stock picking, retail investors tend to be bad at it. Theoretically, ETFs can give an investor diversified exposure to a market, a sector or a theme. And while thematic investing across sectors is in my view a great idea and something that should be embraced more by institutional investors, retail investors miss out on the benefits of this approach because of their behaviour.
Morningstar regularly published reports about what they call the behaviour gap. The behaviour gap is simply the difference between a fund’s performance if an investor had bought the fund and held on to it for the long run, vs. the performance the average investor experienced because of buying and selling the fund in the interim.
In November, Morningstar published a special report on the behaviour gap for investors in thematic funds and if you are familiar with the traditional behaviour gap studies you might want to sit down before you read the following numbers.
The chart below shows the behaviour gap for the last five years across conventional funds, broad thematic funds and thematic funds focusing on specific sub-groups of the thematic investment universe. Plus, within the sub-groups, the behaviour gap is split between ETFs and open-ended funds, most of which will be actively managed funds.
Behaviour gap across different thematic funds
Source: Morningstar
As an explanation, ‘physical world’ thematic funds group together investment themes that are rooted in the real economy but not tech-related, such as green energy, resource management or food-related themes. ‘Tech’ thematic funds focus on the many tech-related themes from AI to fintech, digital infrastructure or life sciences and biotech. ‘Social’ theme, meanwhile comprises themes like demographics or the behaviour of different consumer groups like Millennials.
Looking through the numbers, several things stand out to me:
Retail investors tend not to stick with a theme for a long time but tend to switch from one theme to another. This creates a larger behaviour gap than for conventional funds.
The more ‘on trend’ a theme is (e.g. the tech themes vs. the more timeless social themes) the larger the behaviour gap because investors are constantly tempted to switch into new themes that are pushed in the media.
Investing in ETFs costs you a lot of money. ETFs tend to have lower fees than actively managed funds, but ETFs are also sooooo much easier to trade. With a click of a button, one has sold the Robotics ETF and switched to the cleantech ETF. And because switching is so easy, investors who own thematic ETFs switch more frequently than investors who own traditional open-end funds. The average loss in performance for open-end thematic funds is large at 2.7% per year. But for thematic ETFs, this loss of performance is an astonishing 6.7% per year! That’s a high price to pay for the ability to trade intraday and fees that are typically about 0.5% lower per year.
When it comes to thematic investing the golden rule of fund investing seems to be more important to heed than in conventional funds: Invest in a fund and stick with it for many years.