Avoid this type of investment fund

Specialized ETFs invest in fashion, overestimated areas, and find research.

The old adage of investing in the stock market says “buy low and sell high.”

However, a relatively new investment fund has attracted new investors to buy when values ​​are highest, resulting in immediate losses, a new study has found.

Attraction? Shopping in fashion investment areas such as marijuana, cyber security and working from home.

“Whether or not people buy them, these securities don’t work when the noise around them disappears,” he said. The co-author of the study is Itzhak Ben-David, a professor of finance at Fisher Business College at Ohio State University.

“They appeal to underdeveloped people in terms of investment. They can get an extra $ 500 and decide to try to earn what they think is easy in the stock market. ”

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

These investment funds are the first type of Exchange Trade Funds or ETFs developed in the mid-1990s. ETFs are investment funds that are traded on the stock markets and set up as mutual funds, holding various shares in their portfolios.

The popularity of ETFs is growing rapidly. By the end of 2019, more than $ 4 trillion had been invested in more than 3,200 ETFs. The original ETFs were broad-based products that mimicked index funds, meaning they invested in large, diversified portfolios like the entire S&P 500, Ben-David said.

More recently, however, some companies have introduced what Ben-David and colleagues call “specialized” ETFs, which invest in specific areas or topics – usually companies that have recently attracted media attention, such as home-based business opportunities.

“These specialized ETFs are being touted as ‘the next big thing’ for investors who are affected by past performance of individual stocks and ignore the risks posed by less diversified portfolios,” said co-author Byungwook Kim, a graduate student. Finance in Ohio.

For the study, the researchers used the Center for Security Pricing Research on ETFs sold in the U.S. market between 1993 and 2019.

The focus was on the 1,086 ETF. Of these, 613 were broad-based investors in large stocks. These are Walmarts of ETFs that appeal to value-conscious consumers, Ben-David said.

The remaining 473 were specialized ETFs that invested in a number of cannabis-related industries. These ETFs appeal to consumers who are willing to pay more because they see Starbucks as higher quality, he said.

“Securities included in specialized ETF portfolios are ‘hot’ stocks,” said co-author Francesco Franzoni, a professor of finance at USI Lugano and chairman of the Swiss Financial Institute. “We saw that these stocks were more exposed to the media and more positively than other stocks in the period leading up to the ETF launch.”

In 2019, new ETFs include products focused on mystery, cyber security and video games. In 2020, new specialized ETFs covered stocks associated with the Black Lives Matter movement, COVID-19 vaccination and the tendency to work from home.

The researchers said that the performance of broad and fundamentally specialized ETFs is very different.

The analysis shows that broad-based ETFs have relatively flat gains over the life of the business. However, specialized ETFs lost about 4 percent of their value per year, and low performance continued for at least five years after launch.

Rabih Mussawi, co-author of finance at Villanova University, said: “Specialized ETFs are disappointing for the average investor.”

“Specialized ETFs are issued close to the highest level of the value of their main stocks and begin to perform poorly immediately after launch.”

The study found that the types of investors who buy specialized ETFs were different from those who invest in broad-based products.

For example, large institutional investors with professional managers, such as mutual funds, pension funds, banks, and donations, generally avoid specialized ETFs.

The study found that institutional investors had 43 percent of the market capitalization of broad-based ETFs in the first year, but less than 1 percent of the market capitalization of specialized ETFs.

In contrast, data from an online discount broker that appealed to individual investors showed that clients were more likely to invest in specialized areas than broad-based ETFs.

Other studies have suggested that investors who use this discount mediation may exhibit “sensational-looking behavior” and describe what they have as “experience and interest.”

The results show that most people should refrain from investing in specialized ETFs, Ben-David said.

“If you buy a private ETF, you’re likely to lose money because the underlying stock is overvalued,” he said.

Meeting: 2021 Annual Meeting of the American Economic Union

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