This explains so much of what happens in investing, with money channeled into what's in vogue. Often this occurs after most of the gains have been captured. Consider the crowd that piled into hedge funds after the financial crisis. Hedge funds had significantly outperformed benchmarks during the prior two decades, driving up assets under management to about $1.4 trillion by 2008. That run ended after 2009, even as assets doubled to almost $3 trillion by 2015. The result was too much money in too narrow a space, leading to significant underperformance.
But it wasn't just hedge funds. Consider Bitcoin, if you bought in 2017; residential real estate in 2007; any endowment mimicking the Yale investment model after the 1990s. Disappointment all around. When a successful strategy begins to attract lots of cash, it often means the easy-money phase is over. If you want to know when a sexy new investment is getting toward the end of its run, watch the capital flows.
No. 4. Lottery-ticket investing: The winner-take-all phenomenon is well-documented, not just among sports stars and pop singers, but for venture-capital, private-equity and hedge-fund managers. A small number of investment firms account for most of the gains. If only we could gain access to that exclusive club, our returns would be much better.
This creates what I like to call the Powerball mentality: This is related to item No. 2., or the high-risk, high-return approach to investing. Alas, to gain entree to the best funds, you only need millions of dollars and a time machine so you can go back and invest with the star money managers of today before they achieved their fabulous gains.
No. 5. Late-cycle overconfidence: OK, I had to sneak one cognitive issue in. It has been a full decade since markets reached their lows in March 2009. Enough time has elapsed for people to forget both their pain and the hard lessons of the financial crisis. The same people who swore off equities in 2009, 2010, 2011 and even 2012 are now diving headlong into risky, crowded trades, kicking themselves all the way for not getting fully invested years ago. The lure of a payoff is enough to overcome their post-traumatic financial stress disorder .
It's hard not to look at this investment landscape and not have the sneaking suspicion that this won't turn out well -- and it may not take very long to find out.
This article provided by Bloomberg News.