Good morning and happy Monday.
Thematic ETFs are back, baby. After a three-year rout, thematics have attracted $76 billion in net inflows since 2024, per a recent Morningstar report. Artificial intelligence, energy transition and defense funds have gathered the most assets.
But while these ETFs are performing well now, with AI funds across the board generating 20%-plus returns, investors aren’t always so good at timing them. There’s a gap between the ETFs’ total return and the return of the average dollar that becomes especially pronounced over longer periods. Plus, they just don’t do as well as index funds. The average thematic ETF returned 5 percentage points per year less than the S&P 500 over the past decade.
Sure, everybody loves a theme, but they usually work out better for parties than for portfolios.
BlackRock, Vanguard, Fidelity Keep Gobbling Up Market Share
The US fund industry is increasingly looking like the juice aisle — that is, concentrated.
BlackRock, Vanguard and Fidelity represent 52% of the mutual-fund and ETF assets under management of the largest 150 firms, according to a Morningstar report. That’s a marked increase over the past decade: In 2014, those three firms plus Capital Group accounted for only 43% of AUM. This concentration allows firms to pass on economies of scale to their investors through lower fees, but also pressures smaller shops with fewer resources to invest in technology and talent, said Alyssa Stankiewicz, principal of parent research at Morningstar.
Concentration in the US fund business “has been increasing over the past as many years as we want to go back,” said Stankiewicz, who is one of the authors of the report. But that doesn’t mean game over for the smaller companies. “Smaller and mid-size shops have many options, including (but not limited to) differentiating themselves in terms of client service and relationships that may look and feel different than at large firms, distinguishing themselves by specializing in a given style or asset class, and through factors such as employee ownership that may attract different types of investment talent,” she said.
Squeezing the Competition
Scale is a huge advantage, Stankiewicz said. “A significant portion of assets [are] managed by just the largest 10 asset managers, and then when you split that out into active and passive, the passive side of things is even more concentrated.”
Per the report:
- On the passive side, five firms manage 89% of US mutual-fund and ETF assets. Vanguard accounts for 44%, BlackRock follows with 21%, and Fidelity and State Street tie for third with 10% each.
- Active funds are less concentrated. The top five firms manage 47% of assets. Capital Group manages 18%, Fidelity follows with 12% and Vanguard with 8%.
The Juice Doesn’t Sell Itself: Smaller issuers have had to get creative in how they win assets, in both product design and promotion. Matt Kaufman, head of ETFs at Calamos Investments, says the firm sees income, protection, growth and diversification, particularly away from bonds, as areas where advisors will look beyond the big names. Jake Hanley, chief growth officer at Teucrium, emphasized the importance of publishing research for getting noticed and capturing flows. “Before a product has a chance to compete for assets it first competes for attention,” he said.
AI’s Winners Extend Beyond the Mega-Caps
Ask most investors where AI profits come from, and they will point to the same handful of large-cap names, on repeat like a five-song playlist.
Patrick Kelly, portfolio manager of the Alger AI Enablers & Adopters ETF (Ticker: ALAI), sees a wider field, looking beyond just the companies building AI to the ones putting it to work to win customers, cut costs, or launch new business lines.
We sat down with Kelly to get into the specifics in our latest ETF Corner, where he explained what he actually looks for before calling a company a real beneficiary, which four industries are potentially vulnerable, why power shortages could stall the buildout, and the number he watches to know the theme is still working.
Franklin Templeton Converts Three Mutual Funds to ETFs
It’s said that moving is one of the most stressful events in life.
But it can also be transformative, which may be the case for three mutual funds in Franklin Templeton’s Fund Allocator Series that are being moved to ETFs. It’s a decision asset managers have been weighing against adding dual share classes or maintaining similar strategies in the different wrappers.
“The conversions are designed to broaden investor access while preserving each fund’s investment objective, substantially similar strategy and historical performance,” a Franklin spokesperson said. “We evaluate the appropriate vehicle on a fund-by-fund basis. In this case, converting these institutional-only funds to ETFs broadens investor access while maintaining continuity for existing shareholders.”
Don’t Everybody Share at Once
Although Vanguard’s patent on share classes expired in 2023 and the SEC has approved exemptions for dozens of firms, Franklin Templeton included, asset managers have been somewhat slow to launch them, said David Cohne, a mutual fund and active management analyst at Bloomberg Intelligence. “Everyone’s filing, but no one’s launching,” he said. “The operational ecosystem is really still catching up. It seems like the regulatory green light came much faster than what we would consider the industry plumbing.”
The affected Franklin funds:
- The U.S. Core Equity Fund will move to the existing $2 billion U.S. Large Cap Multifactor Index ETF.
- The International Core Equity Fund will become the Franklin Core International Enhanced Equity ETF, a new product.
- And the Emerging Market Core Equity Fund will become the Franklin Core Emerging Market Enhanced Equity ETF, which is also new.
Mover Advantage: Moving the whole strategy to an ETF wrapper rather than doing a dual share class has a couple of advantages. “It offers immediate scale, an existing track record, existing assets, and so it can help sell the ETF as opposed to launching a new share class,” Cohne said. It also avoids maintaining two distribution structures around the same portfolio. “A full conversion is just cleaner if they think that ETF wrapper is a better long-term home for that strategy.”