Retail investors are causing waves in the investing scene and can have a real impact on your returns.
Long-term investors need to weather the volatility caused by viral stock buying and ensure their fund managers are considering this growing market force when making decisions.
An ailing computer games retailer sees its share price increase 100-fold, a joke cryptocurrency soars to a multi-billion dollar asset class, and near-bankrupt car rental and cinema companies gain billions in value overnight. A good lesson is that investing can always get far weirder than you think.
Before 2021, retail investors were seen as a relatively small, inconsequential portion of the market. Then the power of the individual became a hot topic as a popular social media forum caused major hedge funds such as Melvin Capital to lose billions of dollars in Assets Under Management.
But before you dismiss this as just another silly market fad, there are real takeaways that long-term investors would be wise to heed.
What’s a meme? It’s a good question, and jokes aside for a second there are deeply rooted human behavioural reasons why memes resonate and take off. You can think of memes as versatile viral narratives, or better still meta-narratives (multi-purpose narratives that can fit a variety of commonly found and familiar types of situations). They are certainly a pop-cultural phenomenon that’s very 2021.
Both GameStop and AMC Entertainment Holdings (AMC), along with many other stocks, have seen their prices skyrocket beyond their calculated market value thanks to an army of individual investors piling on the bandwagon. Many novice investors took their first steps into the investing world in 2020 and 2021 as a combination of lockdown boredom and stimulus checks gave them the opportunity to dip their toes into the water. Stories of individuals making tons of money through cryptocurrency would further tempt the inexperienced to start investing with dreams of getting rich quick.
However, easy gains weren’t the only motivation for this sudden interest by the public. Many members of wallstreetbets (the reddit forum behind the GameStop ‘short squeeze’ back in January) wanted to protect “underdogs” from the short-sellers they believed were sabotaging small companies and manipulating markets. This theme of public justice meant that many investors in GameStop simply weren’t in it for the money, and didn’t mind losing a portion of their investment if the overall effect was positive for the companies they were supporting. This is an unusual concept for most professional investors where financial considerations are by far the most important, and can make future outcomes even more unpredictable.
The winners and the losers
Unfortunately, not all investors were prepared to sacrifice their cash for the greater good. In the wallstreetbets situation, the huge gains were temporary and some retail investors lost due to buying near the peak. So while memestocks can bring great results for retail investors who time their trades right, the hype will die down and some will inevitably lose out. Some may see these memestocks as bubbles and just temporary noise, but GameStop is still trading significantly above its pre-craze price. I’ll leave Wall Street to decide if it’s overvalued, but it’s hard to deny that individual investors can affect the markets long term.
Dogecoin, a cryptocurrency, is another success story of viral fame. Originally produced as a joke, social media and Elon Musk made it so popular now has a market cap of £21.7bn (as at 4 October 2021).
Source: https://www.cryptohinge.com/why-is-dogecoin-so-popular/ and https://www.coinbase.com/price/dogecoin
In addition to individuals, there are companies stirring up and cashing in on the demand from retail investors. Robinhood, a commission-free investing platform, publicly filed for its Initial Public Offering (IPO) on 1 July 2021. Although its IPO failed to meet the company’s high expectations, they managed to raise almost $2bn, meaning a valuation of $32bn1. Since the start of 2021, the number of Robinhood’s registered users has doubled to 31 million2, which demonstrates the surge in the number of retail investors and the benefits this can bring to those companies offering them a way to invest.
1 source: https://www.cnbc.com/2021/07/28/robinhood-valued-at-32-billion-after-selling-shares-in-ipo-at-38-per-share-source-says.html 2 source: https://www.ft.com/content/ae0c41a2-0f68-4331-984a-3fd9cf8b6fc2
What does this mean for markets and larger investors?
Memestocks aren’t only relevant to redditors. As a consequence of AMC Entertainment Holdings being recently added to the MSCI World Index, passive investors will now directly own this type of stock. Any actions taken by the retail investor community can have an impact on your returns, whether you like it or not.
As Rory Sturrock suggests in this blog, asset managers could monitor social media to keep ahead of potential trends. Memestock trackers are already displaying real-time performance based on trends from the wallstreetbets forum, such as YoloStocks and memestocks.org. Funds could stand to benefit from being dynamic and reacting quickly to day-traders. On the other hand, if memestocks really are just short-term volatility in the market, then it would make sense to ignore the trends completely and continue investing for the long-term based on researched data and reasoned expectations. Either way, all investors should ensure they have clear goals and set an appropriate investment strategy with diversification, and adequate risk management that helps them withstand any wild fluctuations in stock prices. Another emerging theme is stewardship. Retail shareholders are less likely to vote in corporate elections. This can lead to issues such as failing to achieve quorum and disproportionate decision-making power. Education is key here; if individuals can group together and cause stock prices to skyrocket, they can also make a difference to those companies by exercising their rights to vote.
Memestocks aren't going away any time soon. Markets are constantly evolving, and the impact of retail investors could indicate a shift in the market dynamics and drivers. This presents both risks and opportunities for longer-term investors:
- Investors need to be cautious when taking short positions, particularly in stocks with high short interest or lots of options written. It shows how risky shorting is, with the ever-present risk you get squeezed out of your position in the short run even if it is “right” in the long run.
- If stocks are subject to heavy retail flows they could be systematically overpriced, with the opposite being true of lower volatility stocks with less popular appeal to the public. This is the thinking behind the low volatility anomaly, an academically backed investment style that profits from a popular love of ‘glamour’ stocks and shunning of less glamorous names which then subsequently go on to deliver higher returns.
- However, current markets go to show that no anomaly is guaranteed to work over all time periods; low volatility stocks have performed poorly for years.
- Another key lesson here is that prices can get driven very far away from fundamentals by flows for very long periods of time (see GameStop). Long-term investors would be wise to recognise and accept this rather than try to fight it. This suggests a need for caution when implementing very concentrated bets and a good dose of humility, it goes to show how difficult individual stock trading really is and supports a case for passive management.
As usual, patience is key for long-term investing; a real-life “this is fine” attitude whilst the flames burn around you. Markets can take time to express fair value, so it’s essential to have a clear strategy and to invest rationally with your objectives and diversification in mind.