While inflows into equity ETFs continue to grow, thematic ETFs, which invest in companies linked to everything from solar energy to robotics to consumers, are also gaining ground. robotics to millennial consumers, are on track for their third consecutive year of net outflows, according to financial data and analysis company Morningstar.

This category, which holds $108 billion in total assets, has lost $5.8 billion in investor capital this year, exceeding outflows of $4.8 billion for all of 2023, according to Morningstar.

"It's winter for thematic ETFs right now," says Taylor Krystkowiak, investment strategist at Themes ETFs, an asset management company specializing in this category.

Returns on broad market indices pose a major challenge for thematic funds this year. The S&P 500, the benchmark index for the US stock market, has climbed by over 22% this year, propelled by gains in influential stocks such as Nvidia and Meta Platforms.

The five largest ETFs tracking the S&P 500 and the Nasdaq 100, another stock market index, recorded inflows of $170 billion this year. On Thursday, the SPDR S&P 500 ETF Trust became the first ETF to reach $600 billion in assets. "It's not that people don't like the idea of themes anymore, but a bull market dominated by a handful of megacapitalizations makes it difficult for any theme to stand out," said Aniket Ullal, ETF analyst at CFRA, a market research firm.

Still bad timing

Part of the challenge, according to Bryan Armour, ETF analyst at Morningstar, lies in the very nature of theme investing. Investors often have poor timing when investing in themes, according to a Morningstar study which found that investors in theme ETFs missed out on two-thirds of returns over a five-year period.

"You have to pick the right theme, then be sure the fund has selected the stocks that will benefit most from that theme, and finally be right in the timing of the fund's purchase," Armour said. "Achieving this triple is difficult."

Even some AI-themed ETFs with significant exposure to market darling Nvidia are struggling to hold onto assets. The Global X Robotics & Artificial Intelligence ETF has seen net outflows of $89 million over the past 12 months, according to the company. Despite holding nearly 13% of its portfolio in the AI chipmaker - almost double the S&P 500's weighting - the fund has only matched the index's performance, up around 39% over the past year.

"We still have a long-term conviction in themes," said Arelis Agosto, head of themes at Global X, which has seen outflows in 19 of its 31 theme funds over the past 12 months. "We take a long-term view."

Cathie Wood's ARK Innovation ETF, which invests in companies promising "disruptive innovation", saw $2.6 billion in outflows in 2024, the largest amount for thematic ETFs, according to Morningstar. The fund is down more than 9% this year.

The fact that thematic funds tend to charge higher fees may diminish their appeal. The average fee for thematic ETFs is 0.62% of the amount invested, while the average fee for ETFs is 0.49%. Investors pay 0.09% to hold 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 theme launches has dropped to 13 this year from 39 in 2023, while theme fund closures in 2024 have already surpassed the 2023 total, with 36 versus 32, according to Morningstar. Themes ETFs is bucking this 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 and Watches of Switzerland.

"I think that when the S&P 500 megacaps stop delivering as they do today, attention will shift to thematic ETFs," concluded Krystkowiak.

Thematic ETFs are often false good ideas. We've written about them twice recently, in Adrien Chavanne's article on why thematic ETFs are struggling to keep pace. To find non-thematic ETFs (and thematic ones too, even if that doesn't sound like a very good idea), we've prepared a tutorial here.