One of the most widely held beliefs on Wall Street is that retail investors are a contra-indicator. That is, retail investors are believed to be herd-following and always late to a bull market. This view, however, is highly anecdotal. Even if fund flows tend to lag market movements, one shouldn’t extrapolate that to a belief that retail investors are buying the wrong stocks. There is absolutely no evidence that Main Street investors systematically invest in underperforming stocks throughout an investment cycle. This is an important distinction because the first reaction we get when explaining CrowdInvest to investment professionals is that the retail investor is usually wrong.
However, the evidence against Wall Street so-called experts is clear. According to Morningstar, more than 70% of mutual fund managers underperformed their benchmarks over the past 1, 3, 5, and 10 years. Because they invest throughout market cycles, these experts are, by definition, picking the wrong stocks. It is now widely reported that these experts, not retail investors, are the ones following the herd and susceptible to groupthink. Lack of diversity and self-preservation are part of the problem.
The American Century Growth Fund has underperformed over the past 3 and 5 years and charges over 1.2% a year in fees. The equally popular Fidelity Magellan Fund has underperformed over the past 5 and 10 years. The mutual funds are not doing their jobs but still collecting their fees.
It is no surprise that the US equity mutual fund industry has faced outflows for the past five years while the ETF industry has grown 33% during the same time. ETF’s are increasingly getting more creative in the indices they track. AlphaClone’s ALFA ETF and Global X’s GURU ETF offer investors the ability to invest in the holdings of some of the best-performing hedge funds, and although we think these are interesting, these ETF’s are still using experts in their investment process. CrowdInvest is similar in that we are collecting the wisdom of other investors. The key difference is CrowdInvest is aggregating the opinions of the retail investor instead of the expert. We are using the “Wisdom of Crowds” theory to construct our indices.
Our first index, the CrowdInvest Wisdom Index (CROWDWIS), just completed its first year since its launch. For the year ending 1/7/16, the CrowdInvest index outperformed the S&P 500 by 1.47%. The index was down 0.56% for the year versus the S&P 500 down 2.04%. During the same time period, the expert driven ETF’s were down double digits. It’s only a year’s worth of data, but Main Street does not seem to be a lagging indicator this cycle.