Analysis-Investors flee thematic ETFs as stock benchmarks soar

By Suzanne McGee

(Reuters) - Investors are leaving exchange-traded funds tied to specific themes, such as artificial intelligence and video gaming, as they flock to funds linked to broad stock-market benchmarks that are hitting record highs.

The run for the exits, however, may slow if the broader market stumbles.

While flows in equity ETFs overall continue to climb, thematic ETFs, which invest in companies tied to everything from solar energy to robotics and millennial consumers, are on pace for their third-consecutive year of net outflows, according to financial data and analysis company Morningstar.

The category, which has total assets of $108 billion, has lost $5.8 billion in investor capital this year, greater outflows than the $4.8 billion for all of 2023, according to Morningstar.

"It's winter for thematic ETFs right now," said Taylor Krystkowiak, investment strategist at Themes ETFs, an asset-management firm focused on this category.

Returns from broad market indexes are setting a higher bar for thematic funds this year. The S&P 500, the benchmark for the U.S. stock market, has climbed over 22% this year, propelled by gains from influential stocks including Nvidia and Meta Platforms.

The five-largest ETFs tracking the S&P 500 and the Nasdaq 100, another equity benchmark, have seen inflows of $170 billion this year. The SPDR S&P 500 ETF Trust on Thursday became the first ETF to reach $600 billion in assets.

"It's not that people don't like the idea of themes any longer, but that a bull market dominated by a handful of megacaps makes it hard for any theme to stand out," said Aniket Ullal, ETF analyst at CFRA, a market-research firm.

BAD TIMING

Part of the challenge, said Bryan Armour, ETF analyst at Morningstar, is the nature of thematic investing itself.

Investors often mistime investing in themes, according to a Morningstar study that found investors in thematic ETFs missed out on two-thirds of their returns in a five-year period.

"You have to pick the right theme, then be sure that the fund has picked the stocks that will benefit most from that theme, and then be right about the timing of when you buy the fund," Armour said. "Getting that trifecta right is tough."

Even some AI-themed ETFs with outsized exposure to market-darling Nvidia have struggled to retain assets. The Global X Robotics & Artificial Intelligence ETF has seen net outflows of $89 million in the last 12 months, according to the firm. Despite the fund having nearly 13% of its portfolio in the AI chipmaker - almost double the S&P 500 weighting - it has performed only in line with the index, with both up about 39% in the past year.