Your short-term investment heroes

Retail investors get lots of love these days due to their seeming success in hurting short sellers with their Gamestop trades. Apparently, these new kids on the bloc are the leaders of the French Revolution of finance, if you trust Anthony Scaramucci:

Anthony Scaramucci @Scaramucci

We are witnessing the French Revolution of Finance

The heroes of this revolutionary army are no longer old-fashioned investors who think about value or profits. They are millionaires and billionaires who have made direct marketing to retail traders a central part of their sales. Bloomberg recently ran a good opinion piece on three of them: Elon Musk (who made his money with a company that took 18 years to make its first annual profit), Cathy Wood (who runs an active ETF that made its money mostly by investing in Elon Musk’s company), and Chamath Palihapitiya (a guy who sets up SPACs to launch more companies like Elon Musk’s).

Ritzholtz Wealth CEO Josh Brown – an influential person on Fintwit and with retail investors in his own right – recently called Palihapitiya the new Warren Buffett. We’ll see about that, but for now, count me amongst the sceptics because the track record of this guy isn’t even a decade long and already includes him creating a venture capital firm that he subsequently “burned down” in 2018, as Axios put it.

Cathy Wood is a particularly interesting case. Her actively managed ARK Innovation ETF has an admirable track record of annual returns of 38.1% per year from its inception in 2017 until 2019 before shooting the lights out in 2020 with a return of 152.5%. The problem just is that if history is any guide, the odds of her repeating this feat in the next three years are very low. 

A study by Jeffrey Ptak from Morningstar recently looked at the performance of funds that made more than 100% return in a calendar year. Of the 123 funds he found that accomplished this feat between 1990 and 2016 only 24 (about one in five funds) made money in the subsequent three years. The average return of these funds over the subsequent three years was a 17% loss per year. However, most of these funds made their 100%-plus return in 1999 just before the tech bubble burst. If we exclude these, the average annual return over the next three years rises to 3.3% per year – still not an endorsement to invest in these funds.

The funds that tended to do the worst are funds that already had positive returns in the three years before their 100%-plus year (just like Cathy Wood did). Only two of these funds managed to also have a positive return after their breakout year. The funds that were able to follow up a year with such extreme returns were funds that had negative returns (sometimes devastatingly negative returns) in the three years before. 

Does this mean that Cathy Wood is about to crash and burn? I don’t know. I admire her track record so far just like I admire Elon Musk’s vision and tenacity in building Tesla. I wish all of them well. But would I invest my money in their projects or follow any of their investment advice? Not in a million years.

Maybe I am just too old for this new kind of market. Or maybe I have been around for too many bubbles and crashes to know how this ends.