I’ve written a lot about the difficulty of chasing individual growth stocks. This is often driven by the magnetic attraction to invest in the Next Big Thing. At any given time, there is a fad that growth investors decide is the wave of the future, and punters pile in.
The thing is, investors don’t call them fads. They are “theme investing strategies,” “new paradigm” companies, or “new economy” stocks. They are the companies of the future operating in the industries of the future, and anyone casting a skeptical eye on them is behind the times.
And unfortunately, as the exchange-traded fund (ETF) and indexing industry has thrived, more and more products are created that are intended to capitalize on these fads. Just because a fund company creates an ETF for a new hot investment area, it doesn’t serve as validation of that idea. It’s just a symptom of a business that will package and sell anything that people will buy.
In a 2021 research paper, Ben-David, Franzoni, Kim, and Moussawi track the performance of “specialized ETFs that track niche portfolios and charge high fees,” concluding that “these products perform poorly as the hype around them vanishes, delivering negative risk-adjusted returns.” Quantifying their analysis, they show that “specialized ETFs persistently generate negative alphas of about −3.1 percent per year.”
Recall that “alpha” means investment outperformance versus your benchmark. So, yup, that means that these strategies, on average, underperform the broader market by over 3 percent per year. That’s huge.
Despite decades of experience watching bubbles pop, human nature drives us to continue to look for the next big thing. It’s hard to avoid the FOMO, I know. We often find ourselves second-guessing a conservative investment stance when speculation is rampant and it seems like every amateur day trader is making money.
Recent history suggests that a knowledge of history and a supercomputer in your pocket may not help you avoid the follies of the past—in fact, there’s an argument that social media has thrown accelerant on the fire of bubble creation.
I lean on my belief that it’s far harder to predict what will change in the future than it is to predict what will stay the same. And so I leave it to others to chase the hot new theme. We are in a rapidly changing world, no doubt. My goal is to identify and invest in the things that will remain.