Ep 53: 3 Reasons “Hype ETFs” fail you

About 35% of the total ETF is encapsulated in the top 10 holdings. Much like many other ETFs, you mostly get to see the top 10 holdings. From the top 10 holdings, I only know like Octa, Amazon  zoom and that’s about it. I don’t know all of them and the goal is not to give you a buy or sell signal neither am I trying to evaluate this ETF.  I’m going to use them as an example to aid me in helping you understand why I believe “Hype ETFs” tend to fail. 

I also want you to know that they are not the only “Hype ETF” in the market. There are many ETFs born out of a hype such as BOTZ, an Automation AI ETF, or YOLO and MJ, weed/marijauna ETF.

So you will see more and more these kinds of Hype ETFs or themed ETFs. After the Hype, then it becomes a Theme, right. I’m going to try to give you some reasons as to why they don’t perform. They usually fail the hype. 

• “Hype ETFs” tend to be late to the game

As the name suggests, Hype ETFs are created because of a sudden surge of a certain theme.  Out of a sudden, there’s a huge demand for the stocks that are relevant within the theme. These Hype ETFs are then created to meet the demand, mostly for Institutional Investors, that are not allowed to directly acquire stocks. They cannot directly buy stocks because of regulation.

Which means that most of these ETF are late to the game because most of the prices of the underlying stocks are already off the roof. Let me just give you some examples, Zoom went from $109 in March 2020 to $250 in June, 2020. Twilio went from $71 in March 2020 to $210 in June 2020. The WFH ETF was only created on 25th June 2020, which means that the fund bought these stocks at seriously steep prices and some at their all-time high.

In order for the ETF to perform, the underlying stocks have to continue to outperform despite many of them already up by a 100%, 150%, 200%, pretty crazy. I am not to say the ETF will definitely lose money but risk-reward analysis will say that if we are buying something at its peak, the downward pressure to go down is higher. 

So in my view, I will avoid these kinds of hype, when there is a hype, prices are usually higher, valuations are higher, my profit potential is lower. Also, I’m a cheapo, I always like to go where there’s a bargain. Like at this point in time, I’m digging through the retail sector. I’m digging through the REITs market because prices are down and I believe there’s a bargain.

• “Hype ETFs” charge 4-6x higher fees than Index Funds

I use the terms Hype and Themed (ETFs/Funds) a bit interchangeably because after the hype dies down, they become just another theme. Some of these funds that we have talked about before, BOTS,  0.68% expense ratio, YOLO, 0.74% expense ratio, WFH (work-from-home) 0.45% expense ratio. So it doesn’t sound high right ? 

if you compare it to the SPY, which is an Index Fund tracking the S&P500 Index (which tracks the 500 “Best US Companies” as indicated by Standards and Poors), they are charging and expense ratio of 0.095%. Which doesn’t seem like much from a linear day to day viewpoint since they are all in the decimals. 

So here’s a little story to elaborate and I want to introduce you to our main character, Xiao Ming, which for all of you who are not Singaporean Chinese, he is an iconic character in every single one of our comprehension written in school. 

So Xiao Ming invested $10,000 in BOTS, the Automation-AI ETF, and his good friend Xiao Hua (another iconic character) invested $10,000 in SPY, the S&P 500 Index ETF.

Here are the results: 

Xiao Ming, $10,000 in BOTZ

Xiao Hua, $10,000 in SPY

Assuming both funds perform at 8% returns per year, at the end of year 10, Xiao Hua would have made about 13% more and at the end of year 20, 50% more than Xiao Ming just because she invested in something with a much smaller expense ratio. Which is why there is a crusade on low expense ratio and high fees unit trust are leaving the scene. 

If you have not heard Episode 46 on Why I don’t buy Unit Trust, do take a listen and here is an attached sheet to show you the impact of fees on your portfolio compounded over time. 

(https://docs.google.com/spreadsheets/d/1ak2eijzhZ2t1ZctUjpnQBCl4JuXpQsndZF6dziBogBQ/edit?usp=sharing)

This does not mean you cannot invest in anything other than Index Funds because they are low fees. It just means you will need to find ETFs or Fund Managers or Financial Planners that can perform above the market even after you deduct their fees, so be picky.

• Many of these “Hype ETFs” will Vanish 

Funds are businesses too, the fund houses need to make sure they can gather enough money under the fund to profit from fees and many of these funds fail as a business. From Morning Star, an investment research firm, 45% of all themed funds (After the Hype, they become another theme) from 2010 are no longer around in 2020.

Many of these big institutional Investors like Insurance Companies, Pension Funds and State Funds are not able to invest in these Hype Funds because they are usually too unique and are not within their Investment framework or regulation. So these Hype funds tend to struggle with gathering money.

When these Hype Funds close down, chances are the investors have lost some money too, I mean if something is profitable consistently, money will come in. On top of making losses and the high fees, this disrupts your investment strategy, definitely an opportunity cost for you. We can discuss extensively about this concept of opportunity cost in another podcast. Broadly speaking, it is to realise that whenever you put your money into something, you are essentially not putting it into another so you are losing out on the other “opportunity” hence opportunity cost.