By Ian Salisbury

ETFs that target stock market themes -- like artificial intelligence, cancer research, or clean energy -- let investors bet on their best ideas without necessarily parsing individual stocks. Most investors end up in the red, according to a new study.

These thematic funds are epitomized by star portfolio manager Cathie Wood's ARK Innovation ETF, commonly referred to by its ticker symbol, ARKK. But it's a fast-growing category that includes plenty of popular funds from industry players like iShares, First Trust, Global X, and others.

To find out how investors really fare in these funds, Morningstar analyst Jeffrey Ptak recently studied returns from more than 270 thematic ETFs with a track record of at least three years.

Ptak looked at not just how the ETFs themselves performed, but how much of those returns fundholders actually reaped. He did this by comparing ETFs' investment performance to the flow of investor dollars into and out of these funds. The upshot: A fund's performance in months when it was flush with investor cash counts more than returns from months with empty coffers.

The results aren't pretty. Ptak found the average dollar invested in a thematic ETF over the past three years resulted in a loss of 7% a year. To put that in context, the S&P 500 has returned about 10% a year over that span.

Anyone who is familiar with the story of ARK Invest's flagship fund won't be wholly surprised. The highly concentrated $6.3 billion ARK Innovation ETF made timely bets on pandemic-era highfliers like Tesla and Zoom Communications, returning 153% in 2020 (not weighted for fund flows.) Investors poured in billions into the ETF, but many got burned when its portfolio fell back toward Earth with a 67% decline in 2022. Its trailing three-year annualized return is negative 9.9%, again not weighted for flows.

ARK Invest didn't respond to a request for comment.

Because of ARKK's outsize prominence, Ptak also looked at how thematic funds fared if he excluded that ETF from the results. Investors did only a bit better, with an average annual loss of about 6% for the past three years. While Morningstar didn't publish asset-weighted returns for individual funds, Ptak did send Barron's a list of funds included the study.

The most popular names include the $6.7 First Trust Dow Jones Internet ETF and the $3.7 billion First Trust Cloud Computing ETF, as well as the $4.9 billion iShares U.S. Medical Devices ETF and the $1.4 billion iShares Global Clean Energy ETF.

First Trust didn't respond to a request for comment. The iShares Thematic ETFs team said in a statement that both sectors could soon enjoy tailwinds: medical devices from a new product upgrade cycle and clean energy from rising electricity demand.

Not surprisingly, ETF managers take a different view of the situation. Pedro Palandrani, head of product research & development at Global X, another popular firm with thematic ETFs, dismissed Morningstar's conclusion.

"These are not meant to be core holdings, but satellite positions that allow investors to capture exposure to emerging trends," he said.

And not all of these funds have fared terribly. The First Trust Cloud Computing ETF, for instance, has returned about 8.5% annually over the past three years (not weighted to account for fund flows.) Still, Ptak says, the issue is timing. Even funds that do post solid returns tend to attract investors after a spate of hot performance, when stock prices have been bid up -- making future gains harder to achieve.

"People are late to the party," Ptak said in an interview Friday.

Of course, while some investors may pile in too late, that's not necessarily fund companies' fault. Palandrani points out that the $1.1 Global X Lithium & Battery Tech ETF, one of the company's most popular thematic funds, launched in 2010.

"That was well before electric vehicles were even a thing!" he said.

Write to Ian Salisbury at ian.salisbury@barrons.com

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January 18, 2025 03:00 ET (08:00 GMT)

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