Investors are hoping for big returns by pouring their money into buzzing topics like working from home and the metaverse across exchange traded funds (ETFs) will instead face raw underperformance, according to a new study.

Researchers have found that ETFs based on these and similar hot topics generate an average return about 30% lower than more diversified funds in the five years after launch.

“When people pursue these popular investing themes, they are going to be disappointed,” said Yitzhak Ben Davidco-author of the study and professor of finance at Ohio State University Fisher College of Commerce.

“These news funds are based primarily on hype and tend to lose value relative to the general market almost upon launch.”

The study was published online recently in the journal Review of financial studies.

ETFs, which were first developed in the mid-1990s, are popular investment funds that trade on stock exchanges and are set up like mutual funds, holding a variety of stocks in their portfolios. .

The popularity of ETFs is growing rapidly. By the end of 2021, over $6.6 trillion was invested in over 3,200 ETFs. The original ETFs were broad-based products that mimicked index funds, meaning 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 “specialty” ETFs, which invest in specific sectors or themes – usually those that have received recent media attention, such as Bitcoin, cannabis and even associated businesses. with the Black Lives Matter movement.

“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,” Ben-David said.

“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.

For the study, the researchers used data from the Center for Research in Security Prices on ETFs traded in the US market between 1993 and 2019.

They focused on 1,086 ETFs. Of these, 613 were broad-based, investing in a wide range of stocks.

The other 473 were specialist ETFs, investing in a specific sector or in several sectors linked by a theme.

The analysis showed that the broad-based ETFs had earnings over the study period that were relatively stable. But specialty ETFs have lost about 6% of their value per year, with the underperformance persisting for at least five years after their launch.

“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,” Ben-David said.

Ben-David gives the example of working from home. The time to invest in this area would have been March 2020 when stay-at-home orders for COVID-19 first emerged, he said. But by the time ETFs specializing around this theme were launched a year later, stocks in this area had already peaked.

Investors in specialist ETFs often put their money in areas that are hyped by traditional and social media, he said.

The researchers found that media sentiment — a measure of positive media coverage of individual stocks contained in a specialty ETF — typically peaked around the same time a specialty ETF was launched.

Positive media coverage tended to wane after the launch as the financial press soured on the future prospects for stocks in the ETF thematic area.

The study found that the types of investors who bought into specialty ETFs were different from those who invested in broad-based products.

For example, large institutional investors that have professional managers, such as mutual funds, pension funds, banks, and endowments, typically avoid specialty ETFs.

Data from online discount brokerage firm Robinhood, which caters to retail investors, showed that its clients are much more likely to invest in specialty ETFs than in broad-based ETFs.

Specialty ETFs also charge higher fees than broad-based ETFs — likely because investors in these trendy areas don’t care as much about fees and just want to be part of the fad, Ben-David said.

The results showed that while specialty ETFs account for around 20% of the ETF market, they generate around a third of industry revenue from fees.

The findings of this study show the dark side of what has been called the “democratization of investing,” Ben-David said.

“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,” he said.

“It looks a lot like junk food. That may be what some people want, but it’s not necessarily good for them.

The study’s co-authors were Byungwook Kim, a finance graduate student at Ohio State; Francesco Franzoni, professor of finance at USI Lugano and director of the Swiss Finance Institute; and Rabih Moussawi, associate professor of finance at Villanova University.

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