Investment fads

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   By Guest Blogger Ryan Lewenza

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What a complete and unmitigated disaster the FTX collapse/bankruptcy is for investors and the broader crypto market. But I guess this shouldn’t be that big of a surprise. How many of these half-baked and cockamamie investment fads have we seen over the years that often end in total collapse, a trail of tears and torpedoed portfolios? It seems like every few years we get one of these overhyped and dubious investment crazes, that invariably blowup on investors. This is the focus of today’s blog.

What is FTX and what happened?

FTX is/was a crypto exchange company, which provided a platform to its customers to buy and store different cryptocurrencies. Started in 2019, FTX had over a million users and was the third-largest crypto platform by volume, just prior to its collapse.

FTX was founded and run by Sam Bankman-Fried (SBF) who’s 30 years old, a former quant analyst at an investment firm and a graduate from the prestigious MIT University.

Sam was an ambitious guy who not only started a crypto exchange company, he also created and managed a large hedge fund called Alameda Research. In the early crypto days SBF got into trading cryptocurrencies after he spotted how Bitcoin traded at different prices across different countries and platforms and developed an arbitrage trade making a nice profit with little to no risk (i.e., he would buy the cheaper Bitcoin in one market and sell it at a higher price on another market).

As SBF got a taste for big trading profits he started to get more aggressive making bigger trades and investments in the crypto markets. Then, like every other hedge fund blowup and bankruptcy, he starts to add leverage to the hedge fund, taking on huge loans. Strike one.

Additionally, through his FTX trading firm he created a new crypto currency or token called FTT. Unbeknownst to investors, customers and regulators, he held lots of the FTT token in his hedge fund, which was a big conflict of interest and showed how intertwined his different businesses actually were.

As the crypto markets came crashing down this year, so did SBF’s investments in the hedge fund, with losses accumulating in the billions. To cover up his losses he then secretly transferred billions of dollars in customer funds and FTT tokens from client accounts at FTX, to his hedge fund. Strike two.

News of the losses at Alameda became public and then strike three! The whole house of cards for SBF came crashing down. Overnight we learned that his hedge fund had lost billions of dollars, that SBF and the hedge fund had loans outstanding that led to margin calls, that SBF had defrauded customers of FTX by transferring assets to his struggling hedge fund, and that essentially it was all one big Ponzi scheme.

FTX was then forced into Chapter 11. SBF lost billions (it’s estimated that he lost $16 billion almost overnight) and he stepped down as CEO. Now SBF is in the crosshairs of multiple US agencies and if what has been widely reported, he’ll likely be sharing a jail cell for his purported fraud with Elizabeth Holmes, former CEO of Theranos.

Bitcoin Price is in Free-fall

Source: Stockcharts.com, Turner Investments

Next up on our list of highly questionable investment fads is the controversial portfolio manager, Cathie Wood, and her Ark Innovation Fund. She was a ‘rock star’ in 2020 as her high growth and innovation stock holdings like Zoom and Robinhood soared higher during the pandemic.

But, like so many other ‘one trick pony’ portfolio managers before her, her fund has come crashing back down to earth, along with people’s perception of her investment acumen and stock picking skills.

Many believed that Cathie had developed a novel investment approach and possessed an uncanny ability to uncover these ‘innovative’ stocks that would transform the world and deliver huge returns, but in reality, she simply benefited from an ephemeral period of certain growth stocks rallying during the pandemic and the record low interest rates.

Now, as rates have moved higher and pandemic stocks like Zoom, Shopify and Draftkings have deflated, her fund has fallen harder than Kanye West’s (sorry ‘Ye’) career and net worth. As seen below, the Ark Innovation Fund is down 75% from its 2021 peak and 60% this year.

Basically all the gains that she made in 2020 have been erased, much like Bitcoin, which coincidently she’s heavily invested in, and even once predicted that Bitcoin would hit $1 million by 2030. That was a doozy of a call.

My misgivings with Ms. Wood and her stock picking is: 1) she pays too much attention to the potential earnings growth of her holdings and not enough attention towards valuations (her stocks trade at nosebleed valuations); and 2) she employs little to no risk management, in my view.

I’ve been in this industry a long-time and have seen these ‘flash in a pan’ PMs who have a blowout year, with people then extrapolating these gains forward. But, all too often, the PMs are unable to re-create their incredible success, and I believe Cathie Wood will likely fall into this camp.

Her stocks and fund have been crushed this year so she could see a trading bounce, possibly on a peak in interest rates, but I think her best days are behind her along with the investment fad of her Ark Innovation Fund.

ARK Innovation Fund down 60% this year

Source: Stockcharts.com, Turner Investments

Finally, and closer to home, I would be remiss if I did not bring up the marijuana craze following the legalization of cannabis a few years back. Just like every investment fad there was huge hype around the burgeoning sector, with tons of companies sprouting up, investment dealers bringing these questionable firms to market, and many investment firms creating new vehicles and ETFs to capitalize on this huge investment ‘opportunity’. Below I chart the Horizons Marijuana ETF and you can see how it’s performed over the last few years. Not so good!

Well, like all the other fads this has fallen far short of the incredibly high expectations, resulting in big losses for most investors.

The point of today’s blog is not to sling mud (well maybe a bit) at SBF, Cathie Wood or Horizon’s Marijuana ETF, but rather to caution readers and investors that more often than not, these overhyped and highly speculative investment fads end up imploding with investors losing their shirt. So avoid this and stick with balanced portfolios. It’s not sexy but it gets the job done.

Horizon Marijuana ETF is Down 44% this year

Source: Stockcharts.com, Turner Investments

Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Investment Advisor, Private Client Group, of Raymond James Ltd.