In other parts pf culture, people who read about trendy topics like working-from-home and the metaverse and buy exchange traded funds (ETFs) will also likely be disappointed. Researchers found that ETFs based on these and similar hot topics earn an average return about 30 percent lower than more diversified funds over the five years after they are launched.
ETFs, which were first developed in the mid-1990s, are popular investment funds that are traded on stock markets and are set up like mutual funds, holding a variety of stocks in their portfolios. Nothing wrong with that, and by the end of 2021, in excess of $6.6 trillion was invested in more than 3,200 ETFs.
Original ETFs were broad-based products that mimicked index funds, meaning that they invested in large, diversified portfolios, such as the entire S&P 500, but some companies have introduced “specialized” ETFs, which invest in specific industries or themes that have received a lot of recent media attention, like Bitcoin, marijuana, and even firms associated with the Black Lives Matter movement.
They appeal to people who believe media attention will equal money and likely have a RobinHood account. Smarter investors know that by the time these funds are created, the money has already been made. Because the fund was only created to capitalize on social media hype.
Work-from-home companies are a good example. If you bought stock in March of 2020 just before pandemic government lockdowns hit, great, but specialized ETFs were scarce then. A year later they were common, which meant no money to be made.
For the study, the researchers used Center for Research in Security Prices data on ETFs traded in the U.S. market between 1993 and 2019. They focused on 1,086 ETFs. Of those, 613 were broad-based, investing in a wide range of stocks. The remaining 473 were specialized ETFs, investing in a specific industry or multiple industries that are tied by a theme.
Broad-based ETFs had earnings over the study period that were relatively flat, the analysis showed. But specialized ETFs lost about 6% of value per year, with underperformance persisting at least five years after launch.
They found that media sentiment – a measure of positive media coverage of the individual stocks contained in a specialized ETF – generally peaked at nearly the same time as a specialized ETF was launched. ETFs charge higher fees, because investors are not trying to make money, they only want to feel like they are part of a trend. Specialized ETFs make up about 20% of the ETF market but generate a third of the industry’s revenue from fees.
Positive media coverage tended to decline after launch as the financial press soured on the future prospects of the 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 the broad-based products. Large institutional investors who have professional managers, such as mutual funds, pension funds, banks and endowments, knew better than to invest in specialized ETFs.
That's not to say mainstream mutual fund managers are immune from perception. If Company X goes up 500 percent in value in 2022, every fund manager knows they are going to be criticized if it is not in their portfolio, they 'missed' it, so they will still buy Company X even at the high for the year.
But specialized EFTs flip the script; they exploit people who want to self-identify as putting their money where their beliefs are, and care more about signaling virtue than generating wealth.
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