Chasing Investment Performance Results in Far More Losers than Winners
Would you like to improve your investment game?
Counterintuitively, you don’t necessarily need to master more fancy moves; it may be a more powerful play to simply reduce your biggest investment mistakes. It’s those false moves that usually cost you the most gained ground.
In particular, I’ve commented before on two common and costly behavioural mistakes, both of which stem from reacting to recent returns instead of patiently positioning your portfolio for future market growth.
- The first such blunder is to give in to a sense of gloom and doom, and sell out at low prices during down markets.
- On the flip side, many investors seem to love chasing after expensive trends in frothy markets. I’ve seen a lot of that behaviour lately, so let’s revisit why that typically doesn’t end well.
Fleeting Passions and Expensive Fashions
Admittedly, it’s tempting to chase investment fads when they are playing out in real time. Unfortunately, it’s only obvious in hindsight which lucky few will be long-run winners, and which of the far greater majority will end up as costly illusions, conjured up by an intoxicating brew of performance-chasing and FOMO (fear of missing out).
Here are four points to help you avoid following fads:
1. Success stories abound. There is always a good story behind every hot investment trend. We humans are remarkable at devising new technologies, ground-breaking opportunities, and out-of-the-box ideas. A few of them pay off handsomely, especially for investors who manage to get in at the beginning of the run. However …
2. By the time it’s in the popular press, it’s usually too late to profit on the news. Once a success story has gone mainstream, it’s too late to get in on its past exceptional performance. You end up buying high and hoping it will go even higher, despite the odds that it won’t.
A recent Canadian example was the full legalization of cannabis with huge amounts of fanfare on October 17, 2018. Trying to capture this trend, Horizons ETFs launched the Marijuana Life Sciences ETF (HMMJ) on April 4, 2017, holding a basket of North American stocks active in the marijuana business. From the initial $10/share price, the EFT skyrocketed to over $24 by September 2018. From there it declined to $22 by the October 17, 2018 legalization date, and then dropped further to $15 by the end of 2018. Currently, this ETF is trading just over $5. Its past performance is horrendous, –53% over the past 12 months, –32% for the past 3 years, and –5.63% per year since inception. So much for following what was garnering the most attention in the media!
3. It’s easy to forget that there are a lot more market losers than winners. Think you can pick the ones with room to grow? Although markets in aggregate have delivered premium returns over time, those returns tend to come from a tiny minority of securities. For example, in a recent report on pursuing individual stock returns, JP Morgan looked at U.S. stock performance from 1980–2021. They found about 10% of stocks across all sectors proved to be “mega winners”, but 66% failed to outperform the Russell 3000 Index, and 42% delivered negative absolute returns. In sharing this and other data, Wall Street Journal columnist Jason Zweig observed,
“Winners like Walmart are vivid. … Failures fade as if they were written in invisible ink — but they are much more common than successes.
4. Your investment attention is up for sale. Despite these points, Bay Street and Wall Street are always looking to capitalize on the next big investment trends. Trade brokers and product manufacturers are no fools. When they see opportunities to make easy money by selling hot hands, they’re happy to “help”. Whether you win or lose they can feast on fat commissions and tasty trading revenues.
Who me, cynical? I’ve covered most of these points in my 2018 piece, Investing fads: Quack like a duck and you may get plucked. I described how there’s even a saying for these sorts of popular feeding frenzies: “When the ducks quack, feed them.” As one source described,
“when investors want to buy something … that something is offered for sale. It doesn’t make any difference if Wall Street knows in its heart of hearts that that something (such as an IPO) is overpriced.”
Consider additional evidence from a recent Morningstar report, “Global Thematic Fund Landscape”, as reported in this recent Globe and Mail piece. Morningstar found the launch rate for new thematic funds (with “themes ranging from artificial intelligence to Generation Z”) more than doubled during the pandemic, attracting more than $806 billion USD in investments between 2020–2021, or nearly triple the amount invested in thematic funds prior to that.
“Since we published the first installment of this paper in early 2020, asset managers have ramped up the supply of these niche and often gimmicky funds,”
But their analysis also found,
“most thematic funds don’t beat global equities over longer periods.”
While recent performance was impressive,
“over the past 15 years, more than three fourths of thematic funds globally have shuttered and just one in 10 survived and outperformed.”
ARK Innovation ETF: The Huge Gap Between Investor vs. Investment Returns
As I reflect on past commentary, the U.S.-based ARK Innovation ETF (ARKK) offers a current example to illustrate how fads may come and go, but the theme remains the same.
ARKK checked all of the boxes in late 2020, with its focus on disruptive technologies (a great story), off-the-charts past performance (152.5% return in 2020), and plenty of popular press. Seemingly overnight, ARK’s bespectacled CEO Cathie Wood began appearing across nearly every financial news outlet around.
Unfortunately, as this Morningstar article pointed out in December 2021, the vast majority of ARKK investors arrived after 2020. According to Morningstar analysis, the fund had posted an average 41.3% annualized return over the past 5 years. But since most of the fund’s investors arrived late to the party, they had only earned a 9.9% annualized return over the same period. Even that might not sound so bad, until you consider the U.S. stock market (measured by the S&P 500) returned 17.9% per year during this same timeframe.
At the risk of piling on, ARKK is now down over 60% from its January 2021 peak. With a –24% return, it was the worst-performing U.S. equity fund in Q1 2022, which means most ARKK investors’ annual returns would look even worse now.
I don’t have any special insight into where the fund will go from here. It may sink or it may swim. Either way, if your goal is to build or preserve wealth to fund your personal financial goals, I think the lesson is to avoid these types of hot, concentrated bets to begin with.
Playing the Long Game
“The long run is a series of crazy short runs.”
What will be the next popular game afoot for investors?
Your guess is as good as mine although as I wrote this piece, I couldn’t help but notice some splashy coverage in a financial trade journal, covering a U.S.-based thematic fund that “taps into rising interest rates.” Go figure. Its manager noted fund returns are designed to go up along with interest rates, but “didn’t say the fund would reduce downside risk or dampen volatility.” The article also noted, the fund “carries a hefty 1% expense ratio”. The fund manager even concurred: “This is an expensive fund to manage.”
There are certainly sensible ways to manage these and other investment risks. But if the “solution” involves playing into a fast-moving trend that has either been causing concern or busting out the lights in the recent past, you may want to pause before proceeding. Especially if you hear any quacking in the background.
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