Offering an alternative to actively managed funds, index-based funds have played an increasingly important role in financial markets globally, particularly in the past two decades, in which 95% of all actively managed large-cap U.S. funds lagged the S&P 500®. As indexing has grown, many passive investors have benefited substantially by saving on fees and avoiding active underperformance. Underperformance in the world’s largest equity market can be partly explained by factors such as positive skewness of equity markets, the professionalization of investment management and cost.
However, the dynamics driving the relative performance of active funds in more narrow or specific markets, including so-called “thematic” funds, are less well understood. In this paper, we show that similar principles apply to the thematics space as well, along with some unique challenges, using the universe of the S&P Kensho New Economies Composite Index to frame our analysis. Underscoring the challenges of active thematic stock selection in this universe, and as Exhibit 1 illustrates, 63% of included constituents underperformed this index over the past four years.