Meme stocks have made a comeback, but investors in funds have shifted their focus elsewhere.

The recent surge in trading activity surrounding meme stocks like GameStop and AMC Entertainment has once again captivated the attention of individual investors. However, despite the excitement of risky trading, the fund industry has not experienced a significant boost in its fortunes.

U.S. thematic funds experienced a significant increase in assets, reaching almost $200 billion in 2021. However, they have subsequently declined to $120 billion, despite the major stock indexes trading at record levels.
In 2021, the industry was abuzz with talk of thematic funds, as interest rates hit record lows and smaller growth stocks experienced a remarkable surge. Cathie Wood’s ARK Investment Management has attracted significant investment to the space, leading to the emergence of imitators throughout the industry.

Numerous exchange-traded funds have been introduced by asset managers, covering a wide range of themes including cannabis investing, clean energy, and the metaverse. This is primarily due to the cost-effectiveness and simplicity associated with launching new ETFs. A number of those funds have since shut down. Investors who were interested in monitoring the recent surge in meme stocks missed out on the opportunity when Roundhill’s MEME ETF shut down at the end of last year due to insufficient demand. “The appeal of thematic ETFs has diminished,” commented Matthew Bartolini, who oversees Americas research for State Street’s ETF business.

Thematic funds are facing challenges in attracting investors, despite the overall positive trend in fund flows in 2024. Investors have been consistently withdrawing funds from U.S.-based thematic funds for nine consecutive quarters, as reported by Morningstar Direct. The outflows during this period have amounted to nearly $20 billion. In the first quarter of 2021, quarterly inflows to the category reached their highest point at $35.8 billion, coinciding with the start of the meme-stock frenzy.

“Many investors experienced significant losses,” commented Kenneth Lamont, a senior manager research analyst at Morningstar. They entered at the highest point. Perhaps they haven’t sold everything, but they certainly aren’t increasing their investments. Pete Pettingill, a 66-year-old retiree in Barrington, N.H., has previously dabbled in themed funds like the ARK Innovation ETF. Pettingill claims to be in a strong financial position, with a significant portion of his portfolio invested in U.S. stocks. He also admits to taking some calculated risks with his investments. “I purchased two of the ARK funds, but I must admit that I succumbed to the excitement,” he remarked. I can only remember a constant feeling of letdown.

After a short exploration of themed funds in 2020 and 2021, he decided to sell. Today, his portfolio consists mainly of blue-chip U.S. stocks and diversified mutual funds and ETFs. According to Morningstar, research indicates that themed funds, which often focus on the technology sector, carry a high level of risk. In fact, nine out of ten of these funds have been found to have greater volatility than the overall global equity market.

Investors who embraced the opportunity were handsomely rewarded during the period of the remarkable surge in the aftermath of the Covid pandemic, according to Lamont. However, the funds faced significant challenges when the Federal Reserve started raising interest rates and companies with long-term profitability prospects fell out of favor on Wall Street.

Specialized thematic funds can pose risks for investors as they tend to be introduced after significant gains in specific stocks, increasing the likelihood of being launched near or after a market peak. Several growth-oriented thematic funds that were introduced three years ago have experienced disappointing returns.

Several funds that have seen an increase in investments this year are focused on artificial intelligence and the new GLP-1 class of weight-loss drugs. Themed funds provide crucial diversification for investors who would typically purchase only one or two stocks to speculate on a trend. “A lot of people value the accuracy that comes with diversification,” commented Dave Mazza, CEO of Roundhill Investments, a company that has recently introduced funds focused on AI and GLP-1 themes.

Mazza made the decision to close Roundhill’s meme-stock ETF last year due to the high concentration of activity in a small number of stocks, which made a broader fund impractical. “Lately, investors have shown a preference for themes that are more tangible,” Mazza said. “Speculation has come to an end due to the change in the interest rate environment.”

Thematic funds are not benefiting from the S&P 500’s recent strong performance. The large-cap index has experienced a significant increase of 25% in the last 12 months, primarily due to substantial gains in Nvidia and other technology stocks. The robust returns suggest that fewer investors feel compelled to seek higher-risk investments in order to outperform the index.

Themed ETFs that are actively managed usually come with annual fees of approximately 0.75%, whereas investors have the option to purchase funds that track broad U.S. stock indexes for as low as 0.02%. Indeed, investors are not completely avoiding risky funds. Single-stock ETFs have gained significant popularity this year, as they offer investors the opportunity to amplify their gains or losses by making leveraged bets on a specific stock. Furthermore, the recent surge in funds dedicated to tracking bitcoin has been incredibly successful.

However, at the moment, diversified index funds reign supreme. Equity ETFs are poised to have an exceptional year in terms of inflows, ranking as the second-best year on record.