Social Investing and Market Psychology

Some of this summer’s events provide interesting hints about the potential pitfalls of social investing. Market neutral hedge funds (e.g. Goldman Sachs Global Alpha fund was down 23% for the month of August) went down in flames when they tripped upon themselves trying to unwind highly levered bets in illiquid markets that had turned sour. Absolute Capital has lost 90% of its value over the last month, while its portfolio of penny stocks has become worthless.  

 

Social investing sites, such as Cake Financial and Covestor, offer a distinct advantage over other investment forums and blogs, by enabling users to build their reputation based on their actual performance. This capability, although it represents a real improvement, should be taken with a grain of salt. Absolute Capital, for instance, has demonstrated superior performance year after year, as evidenced by its multiple awards.

 

Obviously, when the market trends upward, an asset’s illiquidity provides an added performance boost. Investors that focus too much on past performance and mirror others’ trades - as enabled by social investing sites - could end up reinforcing unhealthy trend, unbeknownst to them. However, when the market turns south, their losses could pile up very rapidly.

Comments

[Rikki Tahta]

Hi - this is Rikki Tahta the CEO of Covestor - that's a great point you make. Two quick points I'd add from my personal experience in the institutional investment world.

a) past performance is only one of the measures that the fund consultants (like Mercer) employ in measuring managers and matching them to institutional funds. A qualitative assessment of the manager is part of the profile, and here social networking has advantages alongside individual interviews.

b) risk measurement is more than just extrapolating from past performance. Following the collapse of Barings and problems at UBS, internal risk controls within banks has been an area of significant investment. However a financial institution can do it on their internal positions where they have 100% visibility of the holdings, it is not possible for you or I to do it as an external investor in Absolute Capital as we don't have visibility.

At Covestor by both requiring visibility and adding institutional grade risk measurement analytics - we are in a position to give an investor following one of our members a much more accurate measure of prospective risk than they would have if they were investing blindly in a fund.

Hope that helps put some context on the issue that we're addressing

cheers Rikki

[Steven A. Carpenter]

Pierre-

Thanks for your interest in these new models of investing. I am the Founder and CEO of Cake and I wanted to respond to your good points.

I agree that the more transparency companies like ours can introduce the better the context is for individual investors to manage their portfolios. I also agree that the investment industry is entirely too performance focused, and more pointedly, too obsessed with short-term performance obsessed (i.e. daily and monthly swings).

That is why on Cake you can see upwards of 10 years of historical transactions and portfolio performance- across all of someone's accounts. Having a complete picture of your own and other investors' performance and risk metrics over time is a more accurate measure of how someone will do in down markets.

Also at Cake, by having the ability to look at aggregated data of investors over long periods of time, we avoid the potential of simply looking at the "hottest" investors and their trades and drawing erroneous conclusions by mistaking momentum for pure skill.

Try it out and let me know what you think.