Why You Should be Wary of Chasing Trends when Investing

New investment ideas frequently gather traction. They saturate the media as industry chroniclers assess their merits and analyse their credentials. Yet while a ‘trendy’ investment can produce decent returns, are the rewards worth the risk?

Changing the way we live and WeWork

When we talk about investment trends we don’t mean industry or societal shifts, we are referring to an idea or company that has gained outsized favour compared to its fundamental strengths. It may also be called a fad or a craze, but a trend may have more longevity than that.

Trendy investments can still, of course, be serious businesses. Witness the recent run of high-profile tech IPOs, mainly in the US. Those leading the charge such as Facebook, Twitter, Uber, Lyft, Slack and Peloton are challenging the way we live and work. But not all of them have made money, and many may never.

In fact, in the US in 2018, 81% of IPOs were unprofitable in the year leading up to their public offerings, according to a University of Florida study¹. Further analysis revealed that from 1975 to 2011 more than 60% of IPOs had negative absolute returns after five years.

There is always reason to be vigilant, evidenced prominently with the spectacular fall from grace of WeWork’s parent The We Company. The office-space behemoth had its valuation slashed from $47bn to $7.8bn and had its own IPO cancelled – and now the company appears to be only propped up by one of its initial backers, Softbank.

Overconfidence is often punished

While the tech sector may seem to be an easy target, it’s worth noting that public companies within the sector collectively employ millions of people and generate huge profits.

But we would give a wide berth to those claiming they have unearthed the next unicorn, or that their investment recommendation is going to be a ‘ten-bagger’ – a term describing an investment that is exited at 10 times the initial investment. Overconfidence is a behavioural bias often visible in the investment industry and one frequently evidenced in the chasing of trends.

Instead, at Netwealth we are advocates of building high quality, globally diversified portfolios that will never deliver extreme returns through ‘punting,’ but are much better suited for investing one’s savings for the long term.

Beware new types of investment trends

While companies always emerge with new products or services sometimes the evolution of a technology will launch new trends. Bitcoin – which we explored in December 2017 – led a wave of cryptocurrencies which soared, slumped and have endured a hugely volatile ride since.

Although the trend persists and evolves, there is no good evidence yet that it may empower investments that are sustainable and stable – even with the might of Facebook and its embattled Libra payment system and associated ‘stable coin’.

Perhaps the most recent cryptocurrency equivalent (for frothy media coverage, at least) has been the acres of coverage devoted to investing in cannabis related companies. Again, while the market is experiencing rapid growth – nearly quadrupling in 2018 according to Fortune² – virtually every cannabis company today is “unprofitable and burning cash” states this Motley Fool report.

Legislation changes may indeed result in the market multiplying further, but it is worth remembering three important points:

1. Investments that are subject to policy risk are likely to be highly volatile.
2. Just because a structural industry shift is occurring, choosing the right companies in those industries is also incredibly difficult, nor does first mover advantage always benefit. Eg, Ask Jeeves.
3. There are currently unanswered questions concerning how sale proceeds and dividends arising from investment in cannabis-related companies might be treated under the Proceeds of Crime Act 2002 (POCA)

With additional examples including vaping and alternative-to-meat companies, apparently attractive investment opportunities often whizz by. But rather like trying to time the market, this is a pursuit in which we do not engage – our view is that one should always be wary of following the crowd.

Be vigilant

Investors will always try and seek an edge. And the investment world constantly reacts to cater for changing appetites and to adapt to an evolving landscape. (For example, only 28 of the FTSE 100’s original firms in 1984 remained in 2017.)

From our perspective, we try to ignore the volatility of short-term fads. Deciding the strategic mix of which assets to invest in over the long term is the main driver of our portfolio returns.

Yet we recognise that investors may like to have a flutter from time to time, perhaps through their ‘pot three’ investment. We would nevertheless urge caution: if you are tempted by what is hot, the very fact that an investment trend has gone viral may well mean you have missed the boat.

Please remember that when investing your capital is at risk.

¹ University of Florida initial public offering (IPO) statistics, 31st December 2018
² Cannabis investments nearly quadrupled in 2018. Fortune, December 2018