Pandemic Boosts Investor Appetite for Niche Funds

 Pandemic Boosts Investor Appetite for Niche Funds

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Green energy funds are among the big winners this year. Onshore wind turbines in Camber, U.K.

Green energy funds are among the big winners this year. Onshore wind turbines in Camber, U.K.

Photo: Chris Ratcliffe/Bloomberg News

Investors poured money at a record clip into funds that track buzzy themes hoping to profit on ways Covid-19 will upend the economy.

“Thematic” funds, which track trends such as cybersecurity, green energy and health technology, took in a record $42 billion in the U.S. and Europe in the first nine months of the year. That is more than in any previous full calendar year, according to
Morningstar
data.

There is no single definition of what makes a fund “thematic,” though generally they differ from traditional index ETFs and mutual funds by investing in stocks that cut across geographies and sectors. They go after companies that benefit from broad changes in society such as digitization, adoption of clean energy, or aging populations.

Some of the most popular among them were funds that concentrate on themes that have done well in the pandemic, especially digital businesses.

The actively managed
ARK Innovation ETF
has taken in more than $5 billion this year so far, and risen around 95%. FactSet data show. The fund invests in companies it believes will benefit from growth in fields including genomics and internet services. It holds stakes in genetic testing company
Invitae Corp
, workplace communications platform Slack Inc. and
2U Inc.,
a company that helps universities offer online degree programs.

“Some of these long-term themes that were generally accepted for the future have been sped up due to the pandemic as a large percentage of the global population is working from home and staying at home,” said Todd Rosenbluth, head of ETF and mutual fund research at research firm CFRA.

In Europe, the Allianz Global Artificial Intelligence fund, has climbed around 50%, and had pulled in more than $1.3 billion by the end of September, Morningstar data show. It holds shares of companies that have benefited from stay-at-home orders, such as
Roku Inc.,
which makes streaming-media devices, and cloud-communications company
Twilio Inc.,

Most of the money in U.S. thematic products is in passive funds that mimic the returns of custom indexes. In Europe, far more money is in actively managed thematic funds.

The inflows into thematic funds are a speck compared with the trillions invested in low-cost index funds. Assets under management in thematic funds stood at a record $215 billion at the end of September, up from $145 billion at the end of 2019, Morningstar data show. Yet the growing niche represents an opportunity for fund managers to charge higher fees.

“The fee pressure is always gonna be there,” said Rahul Bhushan, investment strategies lead at Rize ETF, a London-based fund issuer. “You can only credibly innovate in an area where people see you as a specialist,” Mr. Bhushan said.

Passive thematic funds in North America charge around 0.59% on average compared with 0.44% for a non-thematic fund. Vanguard’s S&P 500 ETF, which trades under the ticker VOO, charges 0.03%.

Asset managers and industry analysts chalk up the success of thematic funds, at least in part, to the fact they offer a clear way to invest in an overarching narrative.

“We’ve seen a greater uptake of products that make intuitive sense, that are doing what they say on the tin,” said Mr. Bhushan. His firm offers funds dedicated to sustainable food production and data privacy, among others.

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Among the big winners this year are funds that bet on renewable energy. The pandemic accelerated a shift away from fossil fuels thanks to government support, low interest rates and falling costs for things such as solar and wind.

BlackRock’s
iShares Global Clean Energy ETF,
which invests in companies such as solar panel manufacturers and wind turbine makers, in the U.S., Europe and Asia, has risen around 70% this year, pulling in more than $1 billion in the process.
Invesco’s
Solar ETF has risen 120%, and pulled in more than $630 million.

The question for investors is whether paying higher fees is worth it. Morningstar research published in February showed that about 32% of thematic funds launched before 2015 had closed. Of those that had survived, only 41% outperformed the MSCI World Index, a broad stock benchmark.

The percentage of theme-based funds that both survive and outperform their benchmarks is “very, very low,” said Kenneth Lamont, a senior research analyst at Morningstar. To profit from thematic investing, investors not only have to identify a growth area, but pick a fund that provides the right exposure to companies in that sector. On top of that, they have to pick the right time to enter the market, he said.

Write to Mischa Frankl-Duval at Mischa.Frankl-Duval@wsj.com