Jan 21, 2021
Day-trader frenzy for trendy stocks is defying decades of losses
This is the perfect time to be a stock picker: Eaton Vance's Yana Barton
Day traders getting rich buying trendy companies from solar power to cloud computing are defying two decades of money-losing history in ETFs that follow the approach.
Stuffed with overvalued stocks, exchange-traded funds targeting the hottest investment themes actually lost as much as five per cent per year on a risk-adjusted basis between 2000 and 2019, according to new research.
It should serve as a reminder that good times don’t last, yet the speculative euphoria surrounding thematic funds keeps growing. One out of every three dollars flowing to U.S. equity ETFs in January has gone to the sector at US$12.6 billion in total.
“Demand for specialized ETFs comes from unsophisticated investors who chase investment ideas that, in their view, will produce higher expected returns,” academics at Ohio State University, Swiss Finance Institute and Villanova University wrote in the paper. In practice, “the underlying assets of these ETFs are overvalued and therefore underperform after issuance.”
Thematic ETFs in the U.S. now manage a record US$142 billion in assets after almost trebling from a year ago.
With ambitions in new, high-growth industries like robotics and space travel, they tend to hold companies surrounded by media hype with a corresponding run-up in the stock price, according to the paper. As a result, they typically include equities with tell-tale signs of over-valuation, like high market-to-book values or elevated short interest.
The authors studied over 1,000 U.S.-listed equity products, tracking both broad-based funds following indexes like the S&P 500 and specialized ETFs tracking sectors and themes. Leveraged, inverse and actively managed funds were not included.
The results were striking: A portfolio of these thematic and sector funds lost 3.1 per cent a year on a risk-adjusted basis after fees. Poor performance typically kicked in at launch. New ETFs fared even worse, shedding five per cent per year.
The retail investor is likely to be bearing the brunt of these losses.
Using data directly from the Robinhood platform, the researchers found that users overwhelmingly favor thematic ETFs over broad-based products. Meanwhile, based on 13F forms, they showed average institutional ownership of broad-based ETFs shortly after launch was about 43 per cent, yet for specialized funds it was just 0.39 per cent.
Of course, it’s possible that thematic funds have come of age. The study period ends before the unprecedented events of 2020, when some of the highest-profile themes were boosted by the global pandemic.
It also excludes active funds like those offered by Ark Investment Management, which have exploded in popularity after successful bets on the likes of Tesla Inc. and Bitcoin.
Either way, for issuers it’s a no-brainer: The research notes that thematic and sector products held just 20 per cent of assets in all ETFs at the end of 2019 -- but brought in a third of industry revenue thanks to their higher fees.
“ETF issuers attract investor attention by designing products that cater to investors’ expectations of high future returns,” wrote Itzhak Ben-David, Francesco A. Franzoni, Byungwook Kim and Rabih Moussawi. “The most important financial innovation of the last three decades, originally designed to promote cost-efficiency and diversification, has also provided a platform to cater to investors’ irrational expectations.”