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How Is “Joe Investor” Actually Investing? By: Analytic Investors

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How Is “Joe Investor” Actually Investing? By: Analytic Investors MARKETING COMMUNICATION | SEPTEMBER 2020 How is “Joe Investor” actually investing? By: Analytic Investors The ease with which retail investors can trade equity securities has risen dramatically this year. The increasing popularity of fintech trading apps like Robinhood—which allow investors to trade quickly on their smartphones—and the availability of zero trading commissions at traditional brokerage houses have made it easier for the average investor to trade equity securities. Market makers such as Citadel Securities (a division of Citadel LLC) report that retail traders now account for about one-fifth of stock market trading and as much as one-fourth of trading on the most active days.1 While the period over which this phenomenon has been observed is too short to merit a performance evaluation of typical retail investors’ investing prowess, we can examine their holdings to gain some insight into the characteristics of their investment portfolios. Here we use data from Robintrack (which tracks how many users hold a certain stock over time) to evaluate the holdings of the typical user of Robinhood’s investment platform. The stereotypical “Joe Investor” (Joe) is perceived as having a predisposition toward large-cap, well- known stocks with strong recent performance as well as a preference for stocks in the information technology sector. However, we’ve found this stereotype to not be the case: Joe actually has shown a tendency to buy low-priced, smaller-cap stocks with poor recent performance. To evaluate the merits of the Joe stereotype, in Chart 1 we’ve contrasted Joe’s actual average portfolio characteristics with the characteristics of the market portfolio.2 Differences from the market results are measured in terms of deviations from the average—with deviations greater than 0.2 in magnitude being significant (probably not attributable to chance). Chart 1: Average Robinhood portfolio active factor exposure relative to Russell 3000 Index 1 April 2018–13 August 2020 1.5 1.0 0.5 0.0 -0.5 Average active exposure exposure active Average -1.0 -1.5 1/8/2018 1/12/2018 1/4/2019 1/8/2019 1/12/2019 1/4/2020 13/8/2020 Beta Dividend yield Earnings yield Leverage Liuidity Momentum Size Sources: WFAM and Robintrack 1. Source: https://www.bloomberg.com/amp/news/articles/2020-07-09/citadel-securities-says-retail-is-25-of-the-market-during-peaks 2. The active exposures are shown in Z scores, which are standardized units that are measured in terms of standard deviations from the mean. FOR PROFESSIONAL/QUALIFIED INVESTOR USE ONLY 1 The consistency of the portfolio characteristics is in stark contrast to the industry composition of the portfolio, which underwent a dramatic change in March 2020, as shown in Chart 2. Almost coincident with the market bottom is a significant shift toward overweights in airlines and consumer services and an associated decline in the internet-related and software industries. These moves appear to represent the belief that two industries most negatively affected by the pandemic (airlines and consumer services) had better prospects than the two technology industries that had been relatively isolated from its eco- nomic effects. Chart 2: Average Robinhood portfolio active industry weight relative to Russell 3000 Index 1 April 2018–13 August 2020 8 6 4 2 0 -2 Active active exposure exposure active Active -4 -6 -8 1/8/2018 1/12/2018 1/4/2019 1/8/2019 1/12/2019 1/4/2020 13/8/2020 Internet Consumer services Airlines Software Sources: WFAM, Robintrack, and BARRA’s USE4L risk model Whether the shifts represent Joe’s informed contrarian view or just a tendency to speculate in low- priced stocks is difficult to untangle. Over 20% of Joe’s portfolio is invested in stocks under $5—a very significant allocation in the context of the U.S. market, where only 8% of stocks are priced under $5. The portfolio’s top five holdings are consistent with the changes in industry composition. While before the pandemic the top five holdings included names like Aurora Cannabis Inc.; FitBit, Inc.; and GoPro, Inc., three months into the pandemic all of the top five were household names that were trading at low prices relative to history. 2. The active exposures are shown in Z scores 2 Joe’s top-five holdings As of 31/12/2019 As of 30/6/2020 1. Aurora Cannabis 1. Ford 2. Ford 2. GE 3. GE 3. American Airlines 4. FitBit 4. The Walt Disney Co. 5. GoPro 5. Delta Air Lines, Inc. Sources: Analytic Investors and Robintrack. For illustrative purposes only and not a recommendation to trade. So, why the change? Barber and Odean (2008)3 argue that attention greatly influences individual inves- tors’ purchase decisions. Investors face a huge search problem when choosing stocks to buy. Rather than searching systematically, many investors may only consider stocks that first catch their attention (for example, stocks that are in the news or that experience large price moves). This tends to lead individual investors to buy attention-grabbing stocks, and it may help explain why the stocks most likely to appear in the average Robinhood account are well-known names that have recently been in the news. Based on this preliminary analysis, it’s evident that quite a few investors using the Robinhood platform are very active, and many are investing in low-priced stocks with above-average risk (as measured by beta). Robinhood portfolios are predominantly invested in very liquid stocks and, as such, probably have little impact on market liquidity. High-beta, low-priced stocks have historically shown to be a relatively poor investment, but only time will tell if Joe’s portfolio proves that it’s different this time. 3. “All that Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors,” by Brad M. Barber and Terrance Odean, Review of Financial Studies, Vol. 21, No.2, pages 765–818, 2008. 3 The Russell 3000® Index measures the performance of the 3,000 largest U.S. companies based on total market capitalization, which represents approximately 98% of the investable U.S. equity market. You cannot invest directly in an index. Beta measures volatility relative to general market movements. It is a standardized measure of systematic risk in comparison with a specified index. The benchmark beta is 1.00 by definition. Beta is based on historical performance and does not represent future results. Standard deviation is the square root of the sum of squared deviations from the mean. It is often used as a measure of volatility, variability, or risk. Standard deviation is based on historical performance and does not represent future results. Diversification does not ensure or guarantee better performance and cannot eliminate the risk of investment losses. The views expressed and any forward-looking statements are as of 28 September 2020, and are those of Analytic Investors; and/or Wells Fargo Asset Management. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the author and are not intended to be used as investment advice. Discussions of markets, companies, and securities generally are not intended as individual recommendations. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any security, company, market sector, or the markets generally. Wells Fargo Asset Management disclaims any obligation to publicly update or revise any views expressed or forward-looking statements. This information is a Marketing Communication, unless stated otherwise, for professional clients, professional investors, institutional investors, investment professionals, eligible counterparties or qualified investors only (as defined by the local regulation in the respective jurisdiction). Not for retail use. Recipients who do not wish to be treated as Professional should notify their WFAM contact immediately. THIS MATERIAL DOES NOT CONSTITUTE AN OFFER OR SOLICITATION IN ANY JURISDICTION OR TO ANY PERSON WHERE IT WOULD BE UNAUTHORISED OR UNLAWFUL TO DO SO. Past performance is not a guarantee or reliable indicator of future results. Any past performance, forecast, projection, simulation or target is indicative and not guaranteed. All investments contain risk. The value, price or income of investments or financial instruments can fall as well as rise and is not guaranteed. You may not get back the amount originally invested. Wells Fargo Asset Management (WFAM) is the trade name for certain investment advisory/management companies owned by Wells Fargo & Company. Unless otherwise stated, WFAM is the source of all data (which is current, or as of the date stated); content is provided for informational purposes only with no representation regarding its adequacy, accuracy or completeness and should not be relied upon; views, opinions, assumptions or estimates are not necessarily that of Wells Fargo & Company, WFAM or affiliates and are subject to change without notice; and information does not contain investment advice, an investment recommendation or investment research, as defined under local regulation of the respective jurisdiction. Distribution in the United Kingdom (UK), European Economic Area (EEA) and Switzerland: Wells Fargo Asset Management (WFAM) is the trade name for certain investment management companies owned by Wells Fargo & Company, including, but not limited to, Wells Fargo Asset Management (International) Limited (WFAMI Ltd.), an affiliated investment management company within WFAM, authorised and regulated by the UK Financial Conduct Authority (FCA), and Wells Fargo Asset Management Luxembourg S.A.
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