ETFs which concentrate on megatrends capture the imagination but results are poor

If ETFs are your thing then stick with traditional ones which mirror stock indices.

Exchange traded funds have become the backbone of many investor sharemarket portfolios.

The proposal that you will never do any worse or better than the index is terribly attractive – except for the growing list of ETFs that do exactly what they are not supposed to do and lose money.

Thematic ETFs, which track everything from AI to crypto, offer investors the opportunity to jump on a bandwagon.

But new data suggests many such funds jump too late, prompting returns that are actually less than mainstream indices such as the ASX 200.

At its worst, these funds don’t just fail investors but fail the wider industry that has been built on the back of financial adviser recommendations that ETFs are always “safe”.

There has already been some convincing research overseas. The Review of Financial Studies report earlier this year found that “thematic ETFs lose about 25 per cent on a risk adjusted basis over their first five years”; the study stretched from 1993 to 2019.

In Australia, this sort of research is not possible because the business is still relatively recent. But a local fund manager, Plato Investment Management, has compiled a comparable report. Investors, should note that active managers such as Plato are head-on rivals with index-focused ETF product managers.

The Plato report has looked at the performance of ASX-listed ETFs in their first 12 months post launch. The results are very much in line with global outcomes.

“We see the average Australian thematic ETF underperforms the benchmark by 20 per cent over the first year since launch,’ the report says.

Is it as bad as it seems? As the legendary financier Sir James Goldsmith used to say: “If you can see the bandwagon it’s already too late.”

But then again, megatrends can play out over a very long period of time; the dotcom boom took at least five years from around 1995 to 2000 before terminating with the dot.com crash.

Betashares is one of the biggest operators in the local ETF market with a menu of thematic ETFs linked with thematics such as solar, the metaverse and electric vehicles.

At Betashares, the figures on thematic fund numbers are not disputed. But senior investment strategist Cameron Gleeson says thematic ETFs are for the long term and investors should expect volatility over the short term.

According to Gleeson: “Investors should have a (long term) time horizon and should avoid chasing short-term gains by trading thematic ETFs or holding for reasonably short time frames.

“Over the long term, a thematic ETF can provide access to a portfolio of companies that are leveraging increased adoption to drive earnings growth which is higher than that of the broader market and potentially less sensitive to the broader economy.”

Gleeson points out that the majority of funds among the 81 offered by Betashares are in “core” or traditional ETF which simply mirrors indices. He also says that thematic ETFs can deliver in shorter time frames such as the Global Cybersecurity ETF (HACK). The Betashares tables shows the cybersecurity thematic fund has returned a strong 15 per cent over one year.

Stockspot group chief executive Chris Brycki runs a fund heavily dependent on exchange traded funds. Brycki says: “When we did our own research we found that new thematic ETFs in Australia lost investors $150m in the previous 12 months.

“The long-term performance figures for thematic fund are not flattering – they suggest that investors’ odds of selecting a fund that will survive and outperform over the long term are slim.”

Brycki is keen on traditional index-based ETFs and sceptical on new-style thematic ETFs.

“We recommend simple, broad low-cost ETFs as they provide the best chance of consistent long-term success.” he says.