Three lessons in retail-investor frenzy
Plus: pension trustees are irrational too
It's been four years since the Covid pandemic broke out. Most of us now look back on how we managed lockdown with a forgiving gaze: Yes, we showered too little and ate too much. But we were locked down! Of course we all went a bit crazy.
This narrative sort of extends to how we see that era’s meme-stock frenzy: Wall Street Bets, GameStop, crypto...Yes, it was weird. But folks were bored and stuck at home! Of course markets went a bit crazy.
Well, one lesson we’ve learned this week is that meme-stock frenzies don't actually require being locked at home bored. They do just fine without it!
I'm talking about the IPOs of Reddit and Truth Social, both of which made a soaring debut on the stock market. Both lack clear paths to profitability, but did it matter? No, it did not. The U.S. elections are round the corner, and Truth Social is owned by Donald Trump. Do boring numbers matters? No, they do not.
Another lesson this week — more of a reminder, really — is that, for most investors, these retail frenzies rarely end well.
After he was convicted of seven counts of fraud, conspiracy and money laundering, FTX founder Sam Bankman-Fried was sentenced this week to 25 years in prison. Irrespective of what exactly happened, the end result had been a vanishing act of $8 billion of clients' money — mostly retail clients. In an interview he gave from jail, SBF made a particularly poignant comment:
"I've heard and seen the despair, frustration and sense of betrayal from thousands of customers; they deserve to be paid in full, at current price (highlight mine)"
This bellies an oft-ignored cost to retail investors: the opportunity cost.
The classic example is Woodford, and this week there was news on this front as well: investors are finally set to receive £185 million, a big milestone payment following the fund's suspension almost five years ago. Investors had already received £2.56 billion through the sale of the fund's assets. All combined, the total package amounts to around 80% of the fund's value at the time of suspension. But that was five years ago!
The UK government was the only one this week to buck the trend of leaning into retail-frenzy. The Treasury abruptly paused the NatWest retail bidding process. It is now reportedly considering other, more 'institutional' selling tactics, including bookbuilds and buybacks.
There was no word as to why the change of heart. At a guess, it's less to do with protecting retail investors who are too excited, and more a concern that NatWest was unlikely to get retail investors excited enough:
In an interview in February, City minister Afolami said the Natwest sale would help catalyse “animal spirits” in the wider market.
Which brings us to the third and final lesson this week: how investment management can play off these retail frenzies.
So far, ETFs have been the way to go. To say Bitcoin recovered in price since 2022 (when FTX imploded) would be a gross understatement; and now middle-of-the-road asset managers offer cheap trackers for investors looking for that particular upside.
But an even better way to play this – and any subsequent – retail gold rush is to be the one selling pickaxes. Observe Goldman Sachs, who are helping clients launch their own ETFs through an 'ETF Accelerator platform'.
The accelerator was set up five years ago, to help clients get their ETFs to market faster and more cost-effectively. In the words of its head:
"Our core institutional clients were calling and asking, 'How do we get into this ETF space? How do we deliver our strategy, active and otherwise, in an ETF wrapper?'"
Since inception, the accelerator helped create five ETFs, the most recent of which listed last week. Initially I thought: just five? In five years?
It probably took some time to get the platform built and tested. With the help of some more of those animal spirits, I suspect its future is bright.
FinText provides training to asset-managers teams wanting to use AI to improve their fund marketing efforts. See for yourself.
Treasure Corner: Pension trustees are biased
Psychologist Daniel Kahneman passed away this week. He had a lifelong curiosity about how people choose, and left a resounding mark on the world by making a deceptively simple statement: they don't do so rationally.
His best-selling book, Thinking Fast and Slow, introduced the concept of emotional vs. logical thinking, shedding light on common cognitive biases in decision-making. Alongside colleagues Amos Tversky and Richard Thaler, Kahneman's legacy extends to influencing retirement planning strategies, especially auto-enrollment features in savings plans.
In honor of his work, today we'll look at a tiny aspect of decision making: fund selection by pension-fund trustees.
A 2021 study from the Actuarial Research Centre titled: Pension Trustee Decision Making looks into the behavioral problem at hand: trustees make decisions as a group, and behavioural biases appear to exist not just at the individual level, but at the investor group level as well.
From the study:
“Judgments around risk as well as risk-taking appear to be unduly influenced by three factors:
First, members of trustee boards have very similar backgrounds and seem to form a relatively homogeneous group, which can lead to higher risk-taking.
Second, trustees make surrogate decisions, which often leads to different risk-taking than if the surrogate were asked.
Similarly, the perception and knowledge of personal liability may also affect risk-taking.” (all emphasis mine)
The study finds evidence for different types of biases. And that’s well and good, but even more interesting is the evidence they find for their relative strength, as dependent on the type of trustee:
"Member-nominated trustees showed stronger biases than employer nominated, with the weakest biases by professional trustees."
Also Happening:
An AI Chatbot created by NYC tells businesses to break the law. The chatbot, made with Microsoft's AI services, has been dispensing flawed advice to businesses, from housing policies to worker rights. For example, landlords were advised they could reject tenants based on income sources (they can't) and owners were told it's fine to take workers' tips (it's not).
Companies and institutions are rushing to implement AI without sufficient understanding of what this technology can and cannot reliably do. These chickens will come home to roost.
Fee cuts fail to make significant impact on European ETF flows. A new study challenges belief that lower fees attract more investors. Morningstar data shows only half of ETFs with reduced fees saw increased flows over five years. Competition drives fee cuts, yet the findings show minimal difference in flow increases between ETFs that cut fees compared to those that did not.