As trade volumes soar on the influx of do-it-yourself investors, fund managers are looking for ways to stay removed from the mania — or, in some cases, to take advantage of it.
Low interest rates, a sharp market rally since early in the pandemic and the easy dissemination of information are challenging portfolio managers, said Kevin Gopaul, president and chief commercial officer of BMO ETFs at BMO Asset Management in Toronto.
With retail investors “driving the market now,” there’s so much flow affecting returns and index levels, Gopaul said. “It’s difficult to have modelled that.”
Total volume on all TMX Group Inc. exchanges in January and February was twice the total from a year earlier. The proportion of retail trading hit 45% of total volume in January compared with an average of 35% in January 2020. According to research firm Investor Economics, Canadians opened more than 2.3 million do-it-yourself accounts last year, almost three times as many as in 2019.
The extreme consequence of this new money has been fluctuations in the stock price of gaming retailer GameStop Corp. and other so-called “meme stocks” driven by self-directed investors.
Gopaul said the surge in retail activity has a broader impact. “The challenge for quant managers is they have to rely upon the data,” such as price/earnings and other financial ratios, he said. “There’s a belief that the old ratios do not apply to the new economy because the companies are not the same.” Try assessing Tesla Inc. as a car company, for example.
Bill DeRoche, chief investment officer and head of AGFiQ Alternative Strategies with Boston-based AGF Investments LLC, said his team is adjusting to elevated trading volumes. “We basically continue to analyze [trading volume] and adapt our models appropriately,” he said.
AGFiQ funds aren’t vulnerable to GameStop-type extremes, DeRoche said. Portfolio managers monitor the percentage of a company’s total shares — or its float — that’s been shorted. “If anything gets above 10%, that would be a huge red flag for us,” DeRoche said. “In a situation like GameStop, more than 140% of the float [was shorted].”
The same goes for the cost to borrow (the fee a brokerage charges to borrow shares for shorting). GameStop’s cost to borrow peaked at around 50%; DeRoche said his team will close positions on stocks that go above 1%.
“If a name is going to be subject to the things we saw with GameStop, in terms of being illiquid and easily manipulated, those aren’t areas we’re looking to play with,” DeRoche said.
Similarly, the investment team at Calgary-based SmartBe Wealth Inc. avoids “outliers and high-beta stocks” in its quantitative momentum ETFs, said Prithy Serrao, the firm’s director of investment strategy and research.
SmartBe uses a “frog in the pan” approach to identify quality momentum stocks. The momentum funds eliminate the top 10% of high-beta stocks because knowing what’s driving their performance is difficult. “We want the steady, continual path to momentum rather than that one-off spike in return,” Serrao said.
A new product takes a different approach. Earlier this month, New York–based investment manager VanEck launched the VanEck Vectors Social Sentiment ETF (NYSE Arca: BUZZ), which tracks an index of U.S. stocks getting attention on social media, online discussion forums and in news articles.
While the VanEck ETF looks to buy the buzz, the GameStop saga has DeRoche and his team monitoring news as a defensive tactic. AGFiQ began using machine learning to help portfolio managers avoid risk from names they might have bought previously.
Gopaul said rapid shifts in investor sentiment and investing styles during the pandemic favour ETFs, which can be launched quickly and respond to new trends (à la BUZZ or the recent flurry of Canadian crypto products). “That’s why there’ve been more launches in the ETF space in more precise exposures,” he said.
A report published in mid-February by Richardson Wealth Ltd. cautioned that thematic ETFs may be contributing to mispricing. Thematic ETFs accounted for 25% of all U.S. equity ETF flows so far this year, despite comprising only a fraction of the overall US$4.6-trillion market.
“When you factor in this secular change to the market participant mix, combined with the sizable inflows into thematic ETFs — which are comprised of many companies that are not very liquid or widely held — it’s likely that there is lots of mispricing going on,” the Richardson report stated.
DeRoche said the early months of 2021 could prove to be the “high-water mark” for retail participation as people return to spending their marginal dollars on entertainment and other things they’ve been denied during lockdowns.
Art Johnson, portfolio manager and co-founder with SmartBe, likened the current retail frenzy to 1999, when online trading platforms were new and everyone was making money. More than a few of Johnson’s friends have been sharing their adventures in options trading this year, he said.
“For years, that kind of mania — self-directed, ‘I can do it myself’ — had left the market after the tech crash and then the 2008 crash,” Johnson said. “And now it’s come back in full force. It shows a new generation is coming back in and [testing] the old lessons.”
Johnson is not convinced the retail investors will last as trading becomes less fun when they begin losing money. In the meantime, financial advisors are in a difficult position.
“As an advisor, you’re kind of damned all the way around,” Johnson said. “If you tell [clients] not to do it and the stock goes up, you’re the biggest jerk in the world. It’s just a very difficult time.”