A major question for investors and asset managers is whether thematic ETFs belong in a diversified portfolio.

Equity exchange-traded fund flows are rising in their assets under management, but thematic ETFs, which focus on sectors such as solar energy and robotics, are facing their third straight year of net outflows with $108 billion in assets and $5.8 billion in losses this year. 

The author of this article, Julia Khandoshko, CEO of the European broker Mind Money, explains the trend. She also examines how forthcoming elections, and the interest rate situation, will affect ETFs.

The editors of this news service are pleased to share these thoughts. As usual, the editors don’t endorse all views of guest contributors. Email tom.burroughes@wealthbriefing.com

Thematic ETFs are struggling to retain investor favour, with many fleeing towards other assets. In 2024, these ETFs saw a massive capital outflow of $5.8 billion, and many are of the opinion that we are entering (or have already entered) a “thematic ETF winter.” 

But here’s the bigger question: does this downturn indicate long-term troubles, or is it just a temporary chill?

Uncertainty shifts investor sentiment
If we look back, thematic ETFs gained their popularity around 2019 to 2021, a period characterised by low interest rates and strong economic recovery after Covid-19. It was a period of economic optimism, a kind of “anything goes” era. Many investors enthusiastically supported innovation and anything that looked shiny and promising. In 2020, in particular, thematic ETFs were among the top-performing assets, attracting a whole €9.5 billion ($10.3 billion) in areas such as energy, robotics, health tech, and others. 

Now, however, we are seeing a noticeable shift towards less specialised, broader index ETFs, which track well-known benchmarks such as the S&P 500 and the Nasdaq 100. This change is not too hard to understand, when you think about it. It is rooted in basic investor psychology: people’s confidence grew shaky in the face of ongoing geopolitical tensions and economic volatility. And when dealing with an unpredictable environment, broad-market ETFs feel like a safer bet, compared with thematic ETFs that focus on niche areas.

The S&P 500 ETFs, for example, track the performance of the best American companies and represent a strategy with decades of solid results. In some ways, I would even say that traditional indices could be considered the original “proto-ETFs.” And, as financial markets continue to evolve – through advances in AI, lower transaction costs, and the growth of “mega cap” companies – index ETFs have become even more effective. Today, outperforming the S&P 500 has become very hard, and so thematic ETFs are stuck in an unenviable position.

Market timing does no favours
The thing about thematic ETFs is that they depend on the hope of a specific sector thriving. For example, an ETF focused on robotics will perform well only if robotics-focused companies see major growth. But this approach does not work in a volatile market. 

It’s easier to overlook the risk of one “theme” underperforming when economic conditions are generally positive. But when they are not, placing narrow bets feels riskier, as the potential losses would be far steeper. Investors worry a lot more about mis-stepping and making the wrong choice, which makes broad-market ETFs more appealing.

There are many geopolitical events ahead, such as the upcoming US elections, for example, that could create further uncertainty and cause investors to shy away from anything niche that could be impacted by possible regulatory shifts. 

When you look at all of this, it’s clear why broader ETFs are being favoured right now.

Is this the end for thematic ETFs, then? 
Not necessarily. Thematic ETFs may be going through a “winter,” but, like the real-world seasons, winter eventually passes and gives way to another growth cycle. This could happen here, as well. When the economy strengthens and interest rates stabilise, we may yet see thematic ETFs regain their appeal.

For now, the big question that investors and asset managers are both asking is whether thematic ETFs still have a place in a diversified portfolio. The answer, as I see it, depends on individual risk tolerance. Anyone looking for a stable portfolio is probably better off focusing on assets that are less reliant on market timing.

But that doesn’t mean that thematic ETFs have no place left. It’s simply important to keep the changing times in mind. Today’s investment environment calls for caution and balanced strategies if we are to weather the chill successfully. Remember that spring for thematic ETFs could be around the corner, but it’s not here yet. Those wanting to support these assets may have to think in the long-term.

About the author
Julia Khandoshko has more than 10 years of experience in technology innovation and capital markets. She is a regular contributor to Reuters, Kitco, US News, CNBC, among others.