Another in the Virgin series: Exciting ideas and companies don’t make good stocks.
In looking at my blog statistics, my posts with the word ‘virgin’ in them performed the best. I’m going to give the people what they want. You’ll be seeing more ‘virgin’ moments in my articles.
A virgin moment derives from a quote in a classic book about Wall Street by Fred Schwed called “Where Are the Customers’ Yachts?”, first published in 1940. He writes, “There are certain things that cannot be adequately explained to a virgin either by words or pictures. Nor can any description I might offer here even approximate what it feels like to lose a real chunk of money that you used to own.”
Much of investing and financial planning has this characteristic. One simply can’t imagine what it’s really like until one has been through it. It feels scarier, more compelling, real, personal, and important than when we see it on a spreadsheet or in an article on our phones.
The first ‘virgin’ moment I described was bear market fear. It exists in bull markets too, usually as a feeling of confidence.
In the last few years almost 200 specialized 'thematic' ETFs and mutual funds have been created. The asset growth of thematic funds quadrupled. Thematic funds offer unique, tactical bets on investment opportunities grouped by a subject or motif. Typically, it’s about technology and our changing future.
They were first imagined and still exist as 'sector' funds, which invest in broad economic sectors like real estate, technology, or aerospace. Now you can go so much further and invest in ideas like exploring outer space (UFO) or artificial intelligence (BOTZ.) You can make a lifestyle bet on an ETF that 'caters to millennial tastes' (MILN), or invests in the 'future of food' (YUMY), or general pet care (PAWS). Here is the list of thematic groups from Morningstar which, include 'blockchain,’ 'aging population,' and 'new silk road.'
Thematic funds tend to be a bull market phenomenon, possibly a result of investor overconfidence and enthusiasm. (There’s a good line that bull markets make everyone look smart.) It’s an intuitive strategy: “Let’s invest in a handful of really smart innovative companies that people are excited about, the growth potential is incredible.”
The most extreme example until the more recent crypto crashes was ARKK technology fund, led by a faith-driven technology zealot. It grabbed headlines for its meteoric 358% payoff which, you could have gotten if you had managed to buy at the bottom of the Coronavirus crash and sell when ARKK peaked in early 2021.
ARKK invested in 'disruptors' like Tesla and Zoom, many of which benefitted from the pandemic. Lead manager Cathy Wood is outspoken, bold, and claims an encounter with the 'holy spirit' drove her to open ARKK. This all seems a little silly in hindsight, but the stocks she bought were being promoted everywhere. They were exciting stories.
Her fans heard a prophet, her detractors a charlatan. Her investors, however, largely lost money. ARKK went from $2 billion in assets to nearly $20 billion by early 2021 before peaking and giving all of that 358% gain back. Despite headline making returns, the majority of investors moved too late, missed the gains, 'chased performance,' and are now unhappy if not devastated.
Broadly, the average thematic investment has done well for the last several years. But the long track record of thematic funds is not good. By the 10th year, a third of thematic funds have closed, a third have underperformed the market, and a third have outperformed. Less than 15% survive 15 years. Wall Street loves to sell them because they can charge high fees. And they get promoted by Wall Street analysts, who systematically over-estimate the growth of high-tech companies, according to the 2019 research by Hersh Shefrin.
If you do want to invest in tech or theme funds you have to get invested before the idea gets hot and sell it when it seems hottest. That’s really hard to do! This is the Virgin moment. It’s impossible to explain to someone how compelling this is unless they have been in that situation. After all, it’s not just an investment you bought, it’s an amazing transformative idea! And you get instant positive feedback - the fund goes up every week.
How could the future of the post-pandemic virtual workplace, climate positive technology, or disruptive consumer services be a bad investment?
It usually is unless you are in very, very, very early. Tons of academic research shows that over time, popular stocks, especially ones in tech, get overvalued. Even ones with strong financials and competitive advantage struggle with their glamour status. There are always exceptions. Apple looks unstoppable, doesn’t it? But so did IBM…
Which stocks do better over time? The distressed, forgotten, boring ones do better. It’s a topic we’ll pick up in another blog.
Themes and ideas might be fun and emotionally compelling, but I like to have the odds on my side. That's the right way to invest for the long term.
