Investing in disappointment: trendy “specialty” ETFs almost always lose money
“It’s kind of like junk food. It might be what some people want, but it’s not necessarily good for them.
Columbus, Ohio- Want to make money in the stock market? If so, avoid investing in “trends” because it’s already too late to get into fashion! Researchers at Ohio State University say people who invest in trendy exchange-traded funds (ETFs) almost always end up losing their money.
Overall, the authors of the study claim that “specialty” ETFs lose about 30% of their value over a period of five years after their launch.
“When people pursue these popular investing themes, they’re going to be disappointed,” study co-author Itzhak Ben-David, professor of finance at Ohio State’s Fisher College of Business, said in an academic statement. .
“These news funds are based primarily on hype and tend to lose value relative to the general market almost upon launch.”
What are specialty ETFs?
First developed in the mid-1990s, these popular funds are publicly traded and set up like mutual funds. They hold a variety of stocks in their portfolio. However, specialist ETFs typically invest people’s money in trending topics like remote work, the “metaverse”, legalized cannabis, bitcoin or even social causes like Black Lives Matter.
At the end of 2021, investors flocked $6 trillion in more than 3,200 ETFs. ETFs originally invested in large, diversified portfolios, such as the entire S&P 500, according to Ben-David. Now many of them focus on these more specific themes that usually get a lot of positive media attention.
“These specialty ETFs are all over the place hyped on social media and other platforms as the ‘next big thing.’ But by the time these ETFs hit the market and become available to investors, it’s already too late to make money,” says Ben-David.
“Specialty ETFs basically boil down to one sentence: ‘You should invest in electric vehicles’, for example. That’s it. Most investors don’t know anything about the ETF’s portfolio stocks, fees, price/earnings ratio. They just want to be part of the trend.
You’re too late to cash out
The Ohio State team used data from the Center for Research in Security Prices on ETFs traded in the US market between 1993 and 2019 during this study. They focused on 1,086 ETFs, including 613 diversified funds with a wide variety of stocks. The other 473 were specialty ETFs that focused on certain industries or a variety of industries that all have the same “theme.”
The results show that the broad-based ETFs had relatively stable earnings throughout the study. On the other hand, specialty ETFs have lost around 6% of their value each year after their launch, a trend that has continued for at least five years.
“It’s not that ETFs are causing the losses. It’s just that they’re almost always launched when the hype for that particular area is at its peak and already starting to wane,” says Ben-David.
The study’s author specifically noted the work-from-home trend as a flawed ETF to invest in now. He explains that the time to invest in work-from-home ETFs was in March 2020, when countries began issuing stay-at-home orders during the pandemic. When these ETFs hit the scene a year later, however, remote work-related stocks had already peaked.
The media tricks people into making bad investments
The study found that investors often place their money in areas that traditional and social media are buzzing about. Media sentiment – a measure of positive coverage of these thematic stocks – has generally peaked just as the specialist ETF was launched.
The positive media coverage then deteriorated, with the financial press reviewing the future prospects of this topic turning negative. Simply put, once financial pundits start saying these themes can’t make any more money, the positive media coverage mysteriously dries up.
Specialty ETFs are also very expensive
The researchers found that large institutional investors who have professional managers, including mutual funds, pension funds, banks, and endowments, avoid specialty ETFs. Meanwhile, brokerages that cater to individual investors are more likely to see their clients invest in specialty ETFs.
The team notes that specialty ETFs also charge higher fees than broad-base ETFs. Ben-David argues that investors in trending topics generally don’t care about fees, because they just want to be part of the trend.
Interestingly, although specialty ETFs only make up about a fifth of the ETF market, they generate a third of industry revenue through their high fees.
“The companies that market these specialty ETFs are supposed to give people what they want. But it’s not a good idea when investors aren’t sophisticated and don’t know how to think about investing,” concludes Ben-David. “It looks a lot like junk food. That may be what some people want, but it’s not necessarily good for them.
The study is published in the journal Review of financial studies.