Morningstar - Q1 2023 - 31

fraud or bad management, can derail
a company's chances of success. Buying a
well-crafted thematic fund is still one
of the more effective ways to diversify away
some of that idiosyncratic or firmspecific
risk while maintaining exposure
to desirable theme-specific risk.
Are Thematic Funds Trendy?
How Can Thematic Funds Be Benchmarked?
Thematic funds by design often disregard
traditional geographic, size, and sector constraints.
While this forms part of their investment
appeal, it also means they can be difficult to
benchmark. In some cases, a broad market
growth or tech index might suffice, but
in other cases these may not be suitable. For
example, a fund that tracks a battery technology
theme may invest in a small basket of
stocks as diverse as Tesla TSLA, an Australian
lithium miner, and a Taiwanese semiconductor
company. What would be the most
appropriate benchmark for such a diverse yet
concentrated exposure?
One solution is to use the Morningstar Thematic
Fund Taxonomy to create thematic peer
groups, which can be used to benchmark a fund's
performance. A peer group portfolio, or
" theme composite, " can be built by equally
weighting a globally domiciled portfolio of funds
that tracks similar themes and rebalancing
every month.3
This will allow a given fund to be compared
against the broad equity market, a
relevant sector index, and the theme average.
As an example, in EXHIBIT 4, we see the
performance of a popular financial-technology
ETF (Global X FinTech ETF FINX) listed
in the U.S. The performance of this ETF has
been mapped against a fintech theme
composite, a relevant global technology index,
and a global equity index. Over most
periods since its inception, the ETF performed
similarly to the global information
technology sector index and outperformed
the fintech theme composite and global
One of the common criticisms of thematic funds
is that they are trendy. Fads come and go.
Investors lose interest in old themes and chase
new ones. This view is not unfounded. In
fact, it would be fair to say that many thematic
funds are trendy by design, and some even
have the word trend in their names.
One way of assessing trendiness is to examine
how frequently funds open and close. On
aggregate, thematic funds have been less likely
to close than all equity funds over the one, three,
five, 10, and 15 years to mid-2022.
Survival Rates
1-Year
3-Year
5-Year
10-Year
15-Year
Thematic (%)
98.5
90.6
83.4
62.4
49.9
Source: Morningstar Direct. Data as of June 30, 2022.
This result may come as a surprise; however,
the figures should be understood within
the context of the booming thematic fund market.
The majority of thematic funds ever launched
have done so since 2017. The trailing five-year
period has seen thematic funds register
strong returns, which has contributed to these
All Equity Funds (%)
96.5
85.5
76.7
57.8
46.6
elevated survival rates. We may get a
fuller picture of thematic longevity once the
market becomes fully saturated with
thematic funds and we enter a prolonged period
of underperformance. It should be noted
that outflows and closure rates remained low
despite the poor thematic returns in the
first half of 2022.
Despite their surprising resilience versus all
equity funds, one third of the thematic
funds that were available to buy 10 years ago
have shuttered, and half closed over the trailing
15 years. As stand-alone odds of success,
these figures still mean that the chances of
selecting a thematic fund that survives
and outperforms global equities over longer
periods remain stacked against the investor.
The long-term closure rates still support a
trendy tag and demonstrate that many funds
have not survived to capitalize on their
chosen theme. High attrition rates point to
product development by spaghetti cannon:
a process that involves firing fund ideas
at a wall and seeing what sticks. It is, however,
important to look beyond averages; not
all thematic funds are born equal, and some
are much less likely to close than others.
For example, the largest thematic fund provider
in the world, Pictet, has closed only one
thematic fund as of this writing.
equity index. The deflating of the tech
bubble in 2022 hit the ETF harder than its peers,
however, and the fund's cumulative returns
since inception have tumbled below
those of the global technology and global
equity benchmarks.
How Can Thematic Funds Fit Into a Portfolio?
Some thematic funds, particularly those
tracking several themes, may be suitable as a
replacement for core growth building blocks
in a portfolio. Many of the funds tagged as broad
thematic, which track several themes, would
3 The core thematic taxonomy data points are now available in Morningstar Direct. A Notebook that allows access to the theme composites and consensus scores will be available in Direct
in Q1 2023.
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Morningstar - Q1 2023

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