LCP associate consultant Jennifer Davidson says that retail investors may have triggered the trend for ‘memestocks’, but that longer-term investors should be aware of the risks and opportunities.
On the surface, memestocks could be dismissed as just another fad. These investments are fuelled by viral activity and often generated by social media platforms such as Reddit and Twitter. Indeed, before 2021, investors in these types of stocks were seen as a relatively small, inconsequential portion of the market.
However, throughout the pandemic, the power of retail investors has come to the fore, most notably when a popular social media forum caused major hedge funds, such as Melvin Capital, to lose billions of dollars in assets under management.
The key question for long-term investors is whether this is just a short-term fluctuation, or can retail/individual investors and memestocks really have an impact on long-term performance?
How memestocks have transformed markets
The surge in memestocks can be linked to Covid-19 when many novice investors took their first steps into the investing world. A combination of lockdown boredom and stimulus checks gave them the opportunity to dip their toes into the water. For example, GameStop saw its prices skyrocket beyond its calculated market value, thanks to an army of individual investors piling on the bandwagon. Inexperienced investors were further encouraged by stories of individuals getting-rich-quick through cryptocurrency.
However, easy gains were not the only motivation for this surge in appetite. Many members of wallstreetbets, which is the Reddit forum behind GameStop’s ‘short squeeze’ in January 2021, wanted to protect small companies they saw as underdogs from the short-sellers they believed were sabotaging and manipulating markets. This sentiment of investing for public justice meant that many investors in GameStop simply were not in it for the money and did not mind losing a portion of their investment if the overall effect was positive for the underdogs.
Some may see these memestocks as bubbles and just temporary noise, but GameStop is still trading significantly above its pre-craze price. I’ll leave Wall Street to decide if it’s overvalued, but it is hard to deny that individual investors can affect the markets long term.
However, memestocks are not only relevant to Redditors. The groundswell of support for AMC Entertainment Holdings has led to it being added to the MSCI World index, meaning that even passive investors will now directly own this type of stock. Any actions taken by the retail investor community can have an impact on your returns, whether you like it or not.
The power of retail investors, and the flows of money they command could be permanent themes in markets going forward. Asset managers might begin to monitor social media to keep ahead of potential trends. Memestock trackers are already displaying real-time performance based on trends from the wallstreetbets forum, such as YoloStocks and memestocks.org.
Opportunist funds stand to benefit from being dynamic and reacting quickly to day-traders. On the other hand, if memestocks really are just short-term volatility in the market, then it would make sense to ignore the trends completely and continue investing for the long-term based on researched data and reasoned expectations.
Either way, all investors should ensure they have clear goals and set an appropriate investment strategy with diversification and adequate risk management that helps them withstand any wild fluctuations in stock prices.
Taking a rational approach to incorporating memestocks
It doesn’t look like memestocks are going away any time soon. Markets are constantly evolving, and the impact of retail investors could indicate a shift in market dynamics and drivers, presenting both risks and opportunities for longer-term investors.
Firstly, investors need to be cautious when taking short positions, particularly in stocks with high short interest or lots of options written. It shows how risky shorting is, with the ever-present risk you get squeezed out of your position in the short run, even if it is “right” in the long run.
Secondly, if stocks are subject to heavy retail flows they could be systematically overpriced, with the opposite being true of lower volatility stocks with less popular appeal to the public. This is the thinking behind the low volatility anomaly, an academically-backed investment style that profits from a popular love of ‘glamour’ stocks and shunning of less glamorous names, which subsequently go on to deliver higher returns.
However, current markets go to show that no anomaly is guaranteed to work over all time periods – low volatility stocks have performed poorly for years.
A final key lesson here is that prices can get driven very far away from fundamentals by flows for very long periods of time (see GameStop). Long-term investors would be wise to recognise and accept this rather than try to fight it. This suggests a need for caution when implementing very concentrated bets and a good dose of humility.
As usual, patience is key for long-term investing – a real-life “this is fine” attitude while the flames burn around you. Markets can take time to express fair value, so it is essential to have a clear strategy and to invest rationally with your objectives and diversification in mind.
*Jennifer Davidson is associate consultant at pensions consultancy LCP
