Morningstar blasts Cathie Wood: thematic tech investing has high failure rates

Morningstar just released a report warning investors on the risks of thematic tech investing that has gained in popularity in the last year. In the United States, thematic funds have attracted strong inflows with assets under management reaching $149 billion as of March this year, up from $49 billion at the end of December 2019. Top 10 funds account for half of the total assets, with Cathie Wood’s ARK Funds dominating the Top 10 list with 4 thematic funds holding around $43 billion as of March 2021.

According to BlackRock, thematic investing is an approach which focuses on predicted long-term trends rather than specific companies or sectors, enabling investors to access structural, one-off shifts that can change an entire industry. Some popular themes include clean energy, cybersecurity, electric vehicles, e-sports, robotics, 3D printing and cloud computing.

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The Morningstar report went into some of the reasons for the general underperformance of thematic funds which are outlined below.

High failure rates of thematic funds

Although thematic investing seems to have done well over the past year, the record over long-time periods is not great. Thematic investors are essentially betting on a technology or trend to unfold in a certain way in the future, which is most certainly not the most optimal approach to investing.

According to Morningstar, the funds suffer from high failure rates with nearly one-third of all thematic funds having closed in the last 10 years and 34% have underperforming the broader equity market.

Thematic funds have high fees

Most of the thematic funds are actively managed and charge high fees, which is a major contributor to the underperformance. As an example, ARK’s innovation fund charges 0.75% in fees and in comparison a passively managed fund such as iShares S&P 500 ETF charges an annual fee of only 0.03%. 

“High fees charged by thematic funds have contributed to their relatively poor performance versus broad market indexes over longer periods,” Morningstar said.

Portfolio concentration poses high risk

Thematic funds usually hold large positions in small-cap stocks which may carry much higher risk in comparison to the broader markets. In times of market turmoil, investors seek refuge in large-cap stocks and the risky thematic funds may see strong outflows.

In light of the high risks of thematic investing, Kenneth Lamont, senior research analyst at Morningstar and the author of the report, suggested:

 â€œBecause of their narrower exposure and higher risk profile, thematic funds are best used to complement rather than replace existing core holdings.”