Want a hot stock tip? Avoid this type of investment fund

January 15, 2021

COLUMBUS, Ohio - "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."

The research was presented earlier this month at the annual meeting of the American Economic Association and is available on the SSRN preprint server.

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.
-end-
Contact: Itzhak Ben-David, Ben-David.1@osu.edu

Written by Jeff Grabmeier, 614-292-8457; Grabmeier.1@osu.edu

Ohio State University

Related Cannabis Articles from Brightsurf:

Cannabis to treat gynecological conditions
A significant number of women would consider using cannabis to treat gynecological conditions, primarily gynecological pain.

Cannabis data lacking, but machine learning could help
Everyone's heard of THC and CBD. But many other active compounds in cannabis interact to influence its effects.

Cannabis use for menopause symptom management
CLEVELAND, Ohio (September 28, 2020)--As legislation relaxes regarding cannabis, it is being used to manage numerous chronic health conditions and mood symptoms.

Prescribed CBD could help people quit cannabis
A benchmark clinical trial published today shows that cannabidiol (CBD) could be a safe and effective treatment for problematic cannabis use.

Pregnant women with depression are more than 3 times more likely to use cannabis
Cannabis use is much more common among pregnant women with depression and pregnant women with depression are more than 3 times more likely to use cannabis than those without depression.

Cannabis compound acts as an antibiotic 
Public health agencies worldwide have identified antibiotic resistance of disease-causing bacteria as one of humanity's most critical challenges.

Cannabis use during pregnancy
The large health care system Kaiser Permanente Northern California provides universal screening for prenatal cannabis use in women during pregnancy by self-report and urine toxicology testing.

Questions and answers about cannabis use during pregnancy
A new study shows that women have many medical questions about the use of cannabis both before and during pregnancy, and during the postpartum period while breastfeeding.

Managing cannabis use in breastfeeding women
As more states legalize medicinal and recreational cannabis use and increasingly decriminalize cannabis, the risk to the growth and development of breastfeeding infants whose mothers use cannabis becomes a growing public health concern.

Cannabis edibles present novel health risks
With the recent legalization of cannabis edibles in Canada, physicians and the public must be aware of the novel risks of cannabis edibles, argue authors in a commentary in CMAJ (Canadian Medical Association Journal).

Read More: Cannabis News and Cannabis Current Events
Brightsurf.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.