Why it pays to steer clear of investment fads

Human beings have always been prone to fads, fashions and manias — and investors are arguably the worst of the lot.

History is full of examples of crazy investment manias, from railways to canals to South Sea stocks and Dutch tulip bulbs, and the irrationality continues to this day.

We seem more prone to investment frenzies than ever. In recent years, we have had US technology, cryptocurrencies, non-fungible tokens (NFTs), special purpose acquisition companies (Spacs) and the GameStop, AMC Entertainment meme stock craze.

In a few rare cases, one person is the centre of excitement. That is the case with Cathie Wood at disruptive technology specialists ARK Invest.

In 2020, her ARK Innovation ETF returned a thunderous 152.52 per cent, which is when the investment world sat up and took notice. Suddenly, her name was everywhere, Wood-mania took root and investors piled in.

In 2021, ARK Innovation fell by 23.36 per cent. In the year to date, it is down another 28.58 per cent, underperforming the overall stock market by 20.47 per cent, according to Stocksverse.com.

It is still up 420 per cent since launch in 2014 but bandwagon jumpers have been hammered hard.

Fads are dangerous things unless you are ahead of the trend, Chris Beauchamp, chief market analyst at online trading platform IG, says.

“Too often, most investors only really hear about them when the big initial moves have already happened, as with ARK Innovation,” he says.

The herd piles in at the point of peak excitement and overpays horribly.

“Afterwards they stick around, hoping that stellar performance will return. Sometimes it does, but frequently it doesn’t, and these investors end up holding the bag while the market moves on to the next big thing,” Mr Beauchamp says.

The trick is to find investments before they become popular, but that isn’t easy, he says.

“Nobody is bothered about looking for stuff that isn’t doing well.”

It is easy enough to draw parallels between investment bubbles of the past and more recent frenzies.

Say, between the “Nifty 50” buy-and-hold Wall Street blue chips that everyone loved in the 1950s and 1960s, and today’s technology titans such as Apple, Amazon, Facebook and Tesla.

Or the high-risk, high-return “go-go stocks” from the bullish 1960s and the 1990s dot-com boom. Or the South Sea Bubble of 1720 and the Brics. The parallels aren’t exact, but the same trends are at play. When mania takes hold, nobody is safe.

Right and wrong doesn’t come into it, either. It is worth noting that the South Sea Company’s royal monopoly included the trading of African slaves to the Spanish and Portuguese empires. That didn't stop investors from piling in.

They say history does not repeat itself but it does rhyme, and the railway mania of the 1840s still resonates today, Mark Leale, head of investment management company Quilter Cheviot’s Dubai office, says.

People thought railways would change the world, and they did, but not without triggering an almighty crash first.

The Industrial Revolution created a rich British middle class who were willing to take risks with their spare money, because interest rates were so low, Mr Leale says.

“Railway companies made investing easy by issuing what we would now call ‘call options’, allowing investors to buy shares with a 10 per cent deposit, with the balance to be paid later,” he says.

When the Bank of England raised interest rates in 1845, railway companies called those options in. Many investors were unable to pay and the bubble burst, with railway projects abandoned, Mr Leale says.

“The message is simple. Avoid crazes and look to get rich slowly, taking into account how much you can afford to invest, your capacity for loss and appetite for risk,” he says.

Yet, humans are herd creatures and it is not easy to go against the crowd, while professional investors cannot afford to be seen missing out on the next big thing, David Morrison, senior market analyst at Trade Nation, says.

“Playing safe and aiming to beat inflation won’t get you rich or noticed. To stay ahead of the pack, serious investors need to identify an opportunity and get in early. That is where fortunes are made. It is also where they are lost,” Mr Morrison says.

Investors are constantly hunting for the next get-rich-quick opportunity. Next up could be energy, or the Metaverse, or something nobody has even heard of yet, Mr Morrison says.

“As long as money remains cheap and plentiful, investors will bet on a new fad in the hope of stealing a first-mover advantage,” he says.

Money has been cheap and plentiful for the past decade, which has helped to drive investment mania. As has globalisation, because investors around the world can pour money into any asset, anywhere, in seconds.

The internet has accelerated everything as online and app-based investment platforms open investing to anyone with a mobile, Andrey Dobrynin, managing director and co-founder of InvestEngine, says.

“While increasing access to investing should be applauded, it has also driven what Warren Buffett called ‘speculative, casino-like trading’,” he says.

Investing is not gambling, or at least, it shouldn’t be, Mr Dobrynin says, but too many trading apps have failed in their duty to educate investors about the risks.

This leaves it to the individual, who should consider their own risk tolerance and build diversified, long-term portfolios, rather than chasing hot assets.

Chinese property may be the next bubble to burst, Vijay Valecha, chief investment officer at Century Financial, says.

“Prices are estimated to be 2.6 times higher than in the US, with a rising number of bond defaults in the sector, notably Evergrande, which has liabilities of a staggering $300 billion,” he says.

Renewable energy may also be in a bubble as money pours in and stocks become overvalued, Mr Valecha says.

“With the US Federal Reserve set to tighten policy as inflation rockets, tailwinds are starting to become headwinds,” he says.

As the era of cheap and easy money draws to a close and inflation rockets, the passion for manias may ease.

New geopolitical realities following Russia’s military offensive on Ukraine should also play a part as the global economy feels the heat and froth goes out of the market.

Mr Valecha’s advice is to avoid the “fluff” of fads and fashions and look to invest in fundamentally strong and resilient companies.

“Always check valuations carefully to make sure you do not overpay for any asset. That will have a major impact on your returns,” he says.

Nothing will stop investment manias for long, Mr Beauchamp says, as they will happen again and again.

“The trick is to avoid being taken in by the hype and only risk a small corner of your whole portfolio. The downside is that you won’t get huge outperformance, but you should avoid the huge downside. Diversification, as ever, is key.”

Greed lies at the heart of every bout of investment mania. As does fear of missing out. All too often, investors are their own worst enemies.