Investors hoping for big profits by putting their money into trending topics like working from home and the metaverse through exchange traded funds (ETFs) are instead likely to face gross underperformance, a new study shows.
The researchers found that ETFs based on these and similar hot topics earn an average return about 30% lower than more diversified funds over the five years after they are launched.
“When people follow these popular investment themes, they’re going to be disappointed,” he said Yitzhak Ben-Davidco-author of the study and professor i Finance at Ohio State University Fisher College of Business.
“These hot-topic funds are largely hype-based and tend to lose value relative to the overall market almost as soon as they’re launched.”
The study was published online recently in the journal Review of Financial Studies.
ETFs, which were first developed in the mid-1990s, are popular investment funds that trade on stock markets and are designed like mutual funds, holding a variety of stocks in their portfolios.
The popularity of ETFs is growing rapidly. By the end of 2021, more than $6.6 trillion was invested in more than 3,200 ETFs. The original ETFs were broad-based products that mimicked index funds, meaning they invested in large, diversified portfolios, such as the entire S&P 500, Ben-David said.
But recently, some companies have introduced what Ben-David and his colleagues call “specialty” ETFs, which invest in specific industries or themes — usually ones that have received a lot of recent media attention, such as Bitcoin, cannabis and even related firms. with the Black Lives Matter movement.
“These specialized ETFs are about areas advertised on social media and other platforms as the ‘next big thing.’ But by the time these ETFs are released to the market and available to investors, it’s already too late to make money,” said Ben-David.
“Specialist ETFs are basically boiled down to a sound bite: ‘You should invest in electric vehicles,’ for example. This is. Most investors in this do not know anything about the shares in the ETF portfolio, the fees, the price-to-earnings ratio. They just want to be part of the trend.”
For the study, researchers used Center for Security Pricing Research data on ETFs traded in the US market between 1993 and 2019.
They focused on 1,086 ETFs. Of these, 613 were broad-based, investing in a wide range of stocks.
The remaining 473 were specialty ETFs, investing in a specific industry or multiple industries related to a theme.
Broad-based ETFs had returns over the study period that were relatively flat, the analysis showed. But specialty ETFs lost about 6% of their value a year, with underperformance continuing at least five years after inception.
“It’s not like ETFs cause losses. It’s just that they’re almost always released when the hype for that particular area is at its peak and has already started to wane,” Ben-David said.
Ben-David gives the example of working from home. The time to invest in that area would have been in March 2020 when the stay-at-home orders for COVID-19 first appeared, he said. But by the time ETFs specializing in that theme were launched a year later, stocks in that area had already peaked.
Investors in specialty ETFs often put their money into areas advertised by traditional and social media, he said.
The researchers found that media sentiment—a measure of positive media coverage of individual stocks included in a specialty ETF—generally peaked around the same time a specialty ETF was launched.
Positive media coverage tended to decline after the launch as the financial press turned sour on the future outlook for stocks in the ETFs thematic area.
The study found that the types of investors who bought into specialized ETFs were different from those who invested in broad-based products.
For example, large institutional investors that have professional managers, such as mutual funds, pension funds, banks and funds, generally avoid specialist ETFs.
Data from online discount brokerage Robinhood, which caters to individual investors, showed that its clients are much more likely to invest in specialist ETFs than broad-based ones.
Specialty ETFs also charge higher fees than broad-based ETFs — perhaps because investors in these trendy areas don’t care as much about fees and just want to be part of the trend, Ben-David said.
The results showed that while specialty ETFs make up about 20% of the ETF market, they generate about a third of the industry’s fee income.
The study’s findings show the dark side of what has been called the “democratization of investing,” Ben-David said.
“The firms that trade these specialized ETFs are supposed to be giving the people what they want. But this is not a good idea when investors are not sophisticated and do not know how to think about investing,” he said.
“It’s a lot like junk food. It might be what some people want, but it’s not necessarily good for them.”
Co-authors on the study were Byungwook Kim, a graduate student in finance at Ohio State; Francesco Franzoni, professor of finance at USI Lugano and senior chair at the Swiss Institute of Finance; and Rabih Moussawi, associate professor of finance at Villanova University.
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