$50-billion letdown: How themed funds lost their mojo in 2019

One of the most hyped segments of the exchange-traded fund industry has hit a rough patch.

Thematic ETFs, which focus on industries such as robotics, blockchain and cannabis, closed 2019 with about $51 billion under management — just 1% more than the previous high point reached 15 months earlier, according to data compiled by Bloomberg Intelligence. By contrast, the overall U.S. ETF industry has grown 20% during the same period and now oversees $4.4 trillion.

That’s bad news for scores of asset managers looking to exploit the popularity of themed investing. With more than 2,000 ETFs competing for market share in the United States, these issuers have focused on emerging trends in a bid to differentiate their companies and their products. But with asset growth now slowing, issuers will have to pick their spots more carefully.

“It’s concerning,” said Edward Lopez, head of ETF product at Van Eck Associates Corp., which runs more than 50 ETFs in the United States, including funds focused on video gaming and agribusiness. “We’re going to be very thoughtful about any thematic that we put out there. We’re not going to try to chase fads.”

Thematic funds gained popularity as investors sought new ways to boost their performance and financial advisors tried to reinvigorate client engagement. Global X Management Co. even trademarked the phrase “conversational alpha” to describe how thematic funds can enhance the investor experience.

But after a 2½-year meteoric rise, themed ETFs lost more than 20% of their market capitalization when stocks plunged in the fourth quarter of 2018. Although managers recouped much of that money last year thanks to a bull market that helped assets inch past the previous high, investors added the least new money to these funds since 2016.

Instead, investors yanked cash from funds devoted to natural resources and from those tracking robotics and artificial intelligence. Despite surpassing the performance of the Standard & Poor’s 500 index, the ROBO Global Robotics and Automation Index ETF saw outflows of $247 million, while the Global X Robotics & Artificial Intelligence ETF lost $170 million to withdrawals.

The U.S.-China trade dispute’s effect on technology-related sectors was the “biggest challenge” to thematic funds in 2019, said Jay Jacobs, Global X’s head of research and strategy, who expects assets to continue to grow over the long term.

Perhaps, but investors made a smart decision moving away from thematic funds in 2019. The S&P 500 returned almost 30%, the most in six years, boosting the performance of diversified products.

Still, it’s not all doom and gloom for thematic funds. Out of the 33 debuts in 2019, several ETFs made a buzz and attracted inflows. For example, the Global X Cloud Computing ETF, which began trading in April, now has $443 million, and the Defiance Next Gen Connectivity ETF has $162 million.

This year, much will depend on the performance of broader markets and whether thematic funds can again offer investors more bang for their buck.

Investors “will find the long-term growth potential in narrow ETFs more compelling,” said Todd Rosenbluth, a CFRA Research analyst who expects modest returns for U.S. equities this year. The 2019 performance “is a short-term blip. There is potential for some of these products to outperform in 2020.”

Gupta and Hajric write for Bloomberg.