The Bright and Dark Sides of Thematic ETFs
AI, EVs, the metaverse... what if you could buy a whole hot future you see in the news? That's the appeal of thematic ETFs. So why did the people who 'bought when it was hottest' tend to end up worst off?
What is a thematic ETF
A thematic ETF bundles companies tied to a specific trend or structural shift (AI, EVs, clean energy, robotics, the metaverse, etc.) together, cutting across industry lines.
Where a sector ETF holds 'one industry within GICS,' a thematic ETF gathers stocks spanning several industries around a single story. For example, an EV theme might include automakers, battery-material makers, semiconductor firms, and charging-infrastructure companies all together.
Because capturing the future in one package is appealing, trendy thematic ETFs often attract a lot of money in a short time.
The dark side: a tendency to launch at the peak of a fad
The problem is that thematic ETFs usually launch 'after the theme is already hot.' The product comes out at a point when the related stocks have already risen sharply and their valuations (value relative to price) have become expensive—and that's exactly when the most money pours in.
Research backs this up. A National Bureau of Economic Research (NBER) paper found that these specialized, thematic ETFs delivered a risk-adjusted excess return (negative alpha) of about -6% per year over their first five years after listing. In Morningstar's tally, too, over the three years through mid-2024, only 9-25% of thematic funds beat a broad, low-cost global index.
In other words, the 'hottest theme right now' may well be the one you're buying at an already-expensive price.
The figures above are values confirmed from the NBER working paper (w28369) and Morningstar's tally. They do not guarantee or predict any specific future performance; they are reference material showing a past tendency.
'Product performance vs. investor performance,' seen through a case
A classic teaching case is the U.S. ARK Innovation ETF (ARKK). It became a star after soaring explosively in 2020, but in 2021 it lost about -23.5%, and its subsequent maximum drawdown from the peak widened to about -77%.
What matters more is the 'investor experience.' Net assets peaked at about $17.3 billion in early 2021, and roughly $7.4 billion flowed in during the first quarter of 2021 alone. In other words, most of the money came in near the peak. As a result, while the product's own long-term return was positive, the 'return investors actually experienced' (the dollar-weighted return), which reflects the timing of the inflows, was heavily negative.
Most of the gains happened when few shareholders were around, and after the crowd rushed in, it fell. This is the biggest trap of thematic investing.
ARKK is not meant to recommend or criticize a specific product; it is a case that shows how 'product return' and 'the money investors actually made' can differ.
Frequently Asked Questions
Q. Are thematic ETFs products you should never buy?
You can't conclude that. The point of this article isn't 'buy' or 'don't buy'; it's that because thematic ETFs tend to launch at a fad's peak and attract inflows, investors who enter late are easily put at a disadvantage. Rather than the theme's story, it's important to soberly assess how expensive the current valuation is and what share of your overall assets is appropriate.
Q. If a thematic ETF rises, can I make that much too?
The product's headline return and the money you actually make can differ. As in the ARKK case, if you buy late after it has already risen a lot, the product's long-term return can be positive while your own experienced return is negative. 'When and at what price you entered' largely determines the outcome.
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📋 Results are based on historical data; past returns do not guarantee future returns.
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