Retail Investors Outperform The Pros During Coronavirus

Retail Investors Outperform The Pros During Coronavirus

over 3 years ago2 mins

A new study shows that retail traders and investment pros were mirror images during March’s stock market dip – but while that's likely left Robinhood’s merry men on top, they may not get so lucky next time 🏹

What does this mean?

You’d think that the rise of professional investing might make for less volatile markets. According to an academic paper released this week, however, it was precisely those stocks most held by big “institutional” investors which saw the biggest – and most negative – swings in value during March’s market selloff.

The higher a stock’s institutional ownership (IO), the more it fell (Source: Glossner et al.)
The higher a stock’s institutional ownership (IO), the more it fell (Source: Glossner et al.)

Panicked professionals fearing a wave of debt defaults sold shares of highly leveraged companies en masse, instead buying into those with stronger finances. The apparent groupthink was perhaps due to money managers’ motivations: not so much avoiding losing money as avoiding doing significantly worse than the competition 🙄

Professionalized investing may therefore actually make markets less stable in times of crisis. But there’s more. An analysis of US discount brokerage Robinhood’s most popular trades – a decent proxy for small-time retail investment overall – shows the platform’s users did exactly the opposite thing to the institutional money, ploughing into the heavily indebted stocks the pros were fleeing.

Robinhooders simultaneously sold sustainable and financially solid stocks (Source: ibid.)
Robinhooders simultaneously sold sustainable and financially solid stocks (Source: ibid.)

Why should I care?

Further analysis shows that the pros reduced their exposure to every industry sector in the first quarter – while retail traders boosted theirs across the board as prices fell. And the latter category’s confidence may have paid off, given the stock market’s subsequent bounceback; energy, for example, had the best return of any sector in the second quarter. In other words, Robinhood users probably beat institutional investors at their own game.

Source: ibid.
Source: ibid.

Encouraged by this success – as well as the paltry returns offered by savings – retail investors may be tempted to once again turn contrarian during the next selloff. But there are big risks.

For one thing, the rush into highly leveraged stocks could have worked out very differently had the US central bank not moved to shore up demand for corporate bonds. Next time prices drop, meanwhile, it’ll be small-time traders who stand to lose all their glitzy gains.

And as retail investors rush to buy shares of Kodak, it’s worth remembering that companies with bad balance sheets_ _– which we’ll teach you to spot in our forthcoming Pack on Analyzing Financial Statements – may yet be in for a reckoning 🤨

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