Meme stocks are back, but fund investors moved on

Assets in U.S. thematic funds peaked at nearly $200 billion in 2021 and have since dropped to $120 billion, according to Morningstar Direct, even though major stock indexes are trading near records.

Thematic funds were the talk of the industry in 2021, when interest rates were ultralow and smaller growth stocks were soaring. Cathie Wood’s ARK Investment Management attracted billions of dollars to the space, prompting copycats across the industry.

Asset managers launched hundreds of exchange-traded funds with such diverse themes as cannabis investing, clean energy, and the metaverse, partly because it’s cheap and easy to launch a new ETF.

Many of those funds have since closed. Investors wanting to track the recent meme-stock resurgence lost their chance when Roundhill’s MEME ETF closed late last year because of lack of interest.

“The shine on thematic ETFs has certainly worn off," said Matthew Bartolini, head of Americas research for State Street’s ETF business.

Thematic funds are struggling to bring in investors even as total fund flows have been strong in 2024. Investors have pulled money from U.S.-based thematic funds for nine consecutive quarters, according to Morningstar Direct, with outflows over that period totaling almost $20 billion. Quarterly inflows to the category peaked at $35.8 billion in the first quarter of 2021, when the meme-stock frenzy kicked off in earnest.

“A lot of these investors really got burned," said Kenneth Lamont, senior manager research analyst at Morningstar. “They piled in at the top. And maybe they haven’t sold everything, but they’re certainly not doubling down."

Pete Pettingill, a 66-year-old retiree in Barrington, N.H., experimented with themed funds such as the ARK Innovation ETF in the past. Pettingill says he is financially secure, has a heavy allocation to U.S. stocks and enjoys “pushing the envelope a bit" with some of his money.

“I bought two of the ARK funds, but I should say I bought the hype," he said. “I can’t recall anything but disappointment."

After a brief foray into themed funds in 2020 and 2021, he sold. Today, he mostly holds blue-chip U.S. stocks and broader mutual funds and ETFs.

Research shows that themed funds, which tend to skew toward the technology sector, are high risk, with nine in 10 exhibiting higher volatility than the broad global equity market, according to Morningstar.

Investors who took that risk were rewarded with eye-catching gains during “the post-Covid everything bubble," Lamont said. But the funds struggled mightily after the Federal Reserve began lifting interest rates and companies that might not turn profits for years went out of vogue on Wall Street.

Niche thematic funds can be dangerous for investors because they often launch following strong gains in a certain group of stocks, making them more likely to be launched near or after a market peak. Many of the growth-oriented thematic funds that launched three years ago have had poor returns.

Among the themed funds that have taken in money on a net basis this year are those tied to artificial intelligence and the new GLP-1 class of weight-loss drugs. For investors who might otherwise be buying one or two stocks to bet on a trend, themed funds can offer important diversification.

“Many folks appreciate getting precision with diversification," said Dave Mazza, chief executive of Roundhill Investments, which has recently launched funds with AI and GLP-1 themes.

Mazza closed Roundhill’s meme-stock ETF last year, in part because the action was so concentrated in a few stocks that a broader fund didn’t make sense.

“Recently, investors have favored themes that are more tangible," Mazza said. “The low interest rate environment encouraged speculation, and that’s ended."

The S&P 500’s strong recent performance isn’t helping thematic funds either. The large-cap index is up 25% over the past 12 months, driven by huge gains in Nvidia and other technology stocks. The strong returns likely mean fewer investors feel the need to put their money in something riskier to beat the index.

Actively managed themed ETFs typically charge annual fees around 0.75%, while investors can buy funds tracking broad U.S. stock indexes for as little as 0.02%.

To be sure, investors aren’t eschewing risky funds entirely. Single-stock ETFs, which allow investors to make leveraged bets on a stock to double or triple their gains or losses, have increased in popularity this year. And new funds tracking bitcoin have been a smash success.

But for now, diversified index funds are king. Equity ETFs as a whole are on track for their second-best year of inflows ever.

Write to Jack Pitcher at jack.pitcher@wsj.com