Specialized ETFs invest in trendy, overvalued areas, study finds.
“Buy low and sell high” says the old adage about investing in the stock market.
But a relatively new type of investment fund is luring unsophisticated investors into buying when values are at their highest, resulting in losses almost immediately, a new study has found.
The lure? Buying into trendy investment areas like cannabis, cybersecurity and work-from-home businesses.
“As soon as people buy them, these securities underperform as the hype around them vanishes,” said Itzhak Ben-David, co-author of the study and professor of finance at The Ohio State University’s Fisher College of Business.
“They appeal to people who are not sophisticated about investing. They may have an extra $500 and decide to try to make what they think is easy money in the stock market.”
These investment funds are a particular type of Exchange Trade Funds, or ETFs, which were first developed in the mid-1990s. ETFs are investment funds that are traded on stock markets and are set up like mutual funds, holding a variety of other stocks in their portfolios.
The popularity of ETFs is growing quickly. By the end of 2019, in excess of $4 trillion was invested in more than 3,200 ETFs. The 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, Ben-David said.
But more recently, some companies have introduced what Ben-David and his colleagues call “specialized” ETFs, which invest in specific industries or themes – usually ones that have received a lot of recent media attention, like work-from-home opportunities.
“These specialized ETFs are often promoted as the ‘next big thing’ to investors who are wowed by the past performance of the individual stocks and neglect the risks arising from under-diversified portfolios,” said study co-author Byungwook Kim, a graduate student in finance at Ohio State.
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. These are the Walmarts of ETFs, appealing to value-conscious consumers, Ben-David said.
The remaining 473 were specialized ETFs, investing in a specific industry, like cannabis, or multiple industries that are tied by a theme. These are the Starbucks of ETFs, appealing to consumers who are willing to pay more for what they see as higher quality, he said.
“The securities that are included in the portfolios of specialized ETFs are ‘hot’ stocks,” said co-author Francesco Franzoni, professor of finance at USI Lugano and senior chair at the Swiss Finance Institute. “We found that these stocks received more media exposure, and more positive exposure, than other stocks in the time leading up to the ETF launch.”
In 2019, the new ETFs included products focusing on cannabis, cybersecurity and video games. In 2020, new specialized ETFs covered stocks related to the Black Lives Matter movement, COVID-19 vaccine, and the work-from-home trend.
The performance of broad-based versus specialized ETFs was very different, the researchers found.
Broad-based ETFs had earnings over the study period that were relatively flat, the analysis showed. But specialized ETFs lost about 4 percent of value per year, with underperformance persisting at least five years after launch.
“Specialized ETFs, on average, have generated disappointing performance for their investors,” said co-author Rabih Moussawi, assistant professor of finance at Villanova University.
“Specialized ETFs are launched near the peak of the value of their underlying stocks and start underperforming right after launch.”
The study found that the types of investors who bought into specialized ETFs were different from those who invested in the broad-based products.
For example, large institutional investors who have professional managers, such as mutual funds, pension funds, banks and endowments, generally avoid specialized ETFs.
The study found that institutional investors own about 43 percent of the market capitalization of broad-based ETFs in their first year, but less than 1 percent of the capitalization of specialized ETFs.
In contrast, data from one online discount brokerage that caters to individual investors showed that its customers are much more likely to invest in specialized than broad-based ETFs.
Other research has suggested that investors using that discount brokerage exhibit “sensation-seeking behavior” and their holdings can be described as “experience and curiosity holdings,” Ben-David said.
The results suggest that most people should be wary of investing in specialized ETFs, Ben-David said.
“If you purchase a specialized ETF, you are likely to lose money because their underlying stocks are overvalued,” he said.
Meeting: American Economic Association 2021 annual meeting
TORONTO – Canada’s main stock index was down more than 200 points in late-morning trading, weighed down by losses in the technology, base metal and energy sectors, while U.S. stock markets also fell.
The S&P/TSX composite index was down 239.24 points at 22,749.04.
In New York, the Dow Jones industrial average was down 312.36 points at 40,443.39. The S&P 500 index was down 80.94 points at 5,422.47, while the Nasdaq composite was down 380.17 points at 16,747.49.
The Canadian dollar traded for 73.80 cents US compared with 74.00 cents US on Thursday.
The October crude oil contract was down US$1.07 at US$68.08 per barrel and the October natural gas contract was up less than a penny at US$2.26 per mmBTU.
The December gold contract was down US$2.10 at US$2,541.00 an ounce and the December copper contract was down four cents at US$4.10 a pound.
This report by The Canadian Press was first published Sept. 6, 2024.
TORONTO – Canada’s main stock index was up more than 150 points in late-morning trading, helped by strength in technology, financial and energy stocks, while U.S. stock markets also pushed higher.
The S&P/TSX composite index was up 171.41 points at 23,298.39.
In New York, the Dow Jones industrial average was up 278.37 points at 41,369.79. The S&P 500 index was up 38.17 points at 5,630.35, while the Nasdaq composite was up 177.15 points at 17,733.18.
The Canadian dollar traded for 74.19 cents US compared with 74.23 cents US on Wednesday.
The October crude oil contract was up US$1.75 at US$76.27 per barrel and the October natural gas contract was up less than a penny at US$2.10 per mmBTU.
The December gold contract was up US$18.70 at US$2,556.50 an ounce and the December copper contract was down less than a penny at US$4.22 a pound.
This report by The Canadian Press was first published Aug. 29, 2024.
The crypto market has recently experienced a significant downturn, mirroring broader risk asset sell-offs. Over the past week, Bitcoin’s price dropped by 24%, reaching $53,000, while Ethereum plummeted nearly a third to $2,340. Major altcoins also suffered, with Cardano down 27.7%, Solana 36.2%, Dogecoin 34.6%, XRP 23.1%, Shiba Inu 30.1%, and BNB 25.7%.
The severe downturn in the crypto market appears to be part of a broader flight to safety, triggered by disappointing economic data. A worse-than-expected unemployment report on Friday marked the beginning of a technical recession, as defined by the Sahm Rule. This rule identifies a recession when the three-month average unemployment rate rises by at least half a percentage point from its lowest point in the past year.
Friday’s figures met this threshold, signaling an abrupt economic downshift. Consequently, investors sought safer assets, leading to declines in major stock indices: the S&P 500 dropped 2%, the Nasdaq 2.5%, and the Dow 1.5%. This trend continued into Monday with further sell-offs overseas.
The crypto market’s rapid decline raises questions about its role as either a speculative asset or a hedge against inflation and recession. Despite hopes that crypto could act as a risk hedge, the recent crash suggests it remains a speculative investment.
Since the downturn, the crypto market has seen its largest three-day sell-off in nearly a year, losing over $500 billion in market value. According to CoinGlass data, this bloodbath wiped out more than $1 billion in leveraged positions within the last 24 hours, including $365 million in Bitcoin and $348 million in Ether.
Khushboo Khullar of Lightning Ventures, speaking to Bloomberg, argued that the crypto sell-off is part of a broader liquidity panic as traders rush to cover margin calls. Khullar views this as a temporary sell-off, presenting a potential buying opportunity.
Josh Gilbert, an eToro market analyst, supports Khullar’s perspective, suggesting that the expected Federal Reserve rate cuts could benefit crypto assets. “Crypto assets have sold off, but many investors will see an opportunity. We see Federal Reserve rate cuts, which are now likely to come sharper than expected, as hugely positive for crypto assets,” Gilbert told Coindesk.
Despite the recent volatility, crypto continues to make strides toward mainstream acceptance. Notably, Morgan Stanley will allow its advisors to offer Bitcoin ETFs starting Wednesday. This follows more than half a year after the introduction of the first Bitcoin ETF. The investment bank will enable over 15,000 of its financial advisors to sell BlackRock’s IBIT and Fidelity’s FBTC. This move is seen as a significant step toward the “mainstreamization” of crypto, given the lengthy regulatory and company processes in major investment banks.
The recent crypto market downturn highlights its volatility and the broader economic concerns affecting all risk assets. While some analysts see the current situation as a temporary sell-off and a buying opportunity, others caution against the speculative nature of crypto. As the market evolves, its role as a mainstream alternative asset continues to grow, marked by increasing institutional acceptance and new investment opportunities.
