The price of FOMO

Now, let's discuss that: How FOMO may impact investor behaviour

You're right. Black Friday shopping is undeniably exciting.

As the UK gears up for the excitement of Black Friday (officially on November 24th), you—like me—may have already started browsing the deals. Or, as an investor, you might be positioning your portfolio to capitalise on next year’s exciting themes.

Now comes the hard part. Can you say no to FOMO (the fear of missing out)?

Few of us can resist the spark of excitement of finding something we like and a bargain. While the mood may be somewhat subdued this year given the pervasive cost-of-living crisis, bagging a bargain is deeply rooted in the concept of "loss aversion".

The point I am making is that emotional shopping—much like emotional investing—can cloud decision-making, with factors like fear of missing out, loss aversion, herd mentality, confirmation bias, and anchoring bias all playing a role. Recent research from Morningstar suggests that many investors in thematic funds may be particularly vulnerable to these psychological biases.

Not everything is as it seems: We know that many advertised “deals” on Black Friday should be taken with “a pinch of salt”.? According to “Which?” (a British consumer champion publication), 98% of last year’s Black Friday “deals” (in the UK) are not the cheapest price of the year.? From a sample size of 208 products, they found:

• 98% were the same price or less at other times of the year
• 45% were cheaper at other times of the year

The land of stories: The challenge for retailers is to turn even the smartest of shoppers into shopaholics on Black Friday. ? Using a blend of design and behavioural science, retailers will try to tap into our psychology and get us to follow the momentum.

Powerful media and social proof often drive us to buy, believing others are grabbing a great deal. This “Fear of Missing Out” (FOMO), amplified by social media, taps into herd mentality. It can lead us to overvalue products simply because they seem scarce, regardless of their true worth.

Just to nudge us to "seek pleasure and avoid FOMO", retailers state that deals are “limited”.? This creates a sense of urgency in our brains. We act quickly to get a bargain.? Look at today's email from Domino’s proclaiming “Today Only! Buy One Get One Free.”? Making matters worse, my local DPD driver mentioned this afternoon that she had done most of her Christmas shopping this week; taking advantage of “great bargains”.? Confirmation bias has meant that I’m back shopping on-line.

A good theme doesn’t always lead to good investments: Investors want to invest in companies that can grow, not just in the short term, but in the long term. Interesting investment opportunities can be found when researching companies benefiting from enduring structural trends in areas like demographic evolution, climate mitigation, digital infrastructure, and energy.

Thematic actively-managed funds and ETFs offer a way to capitalise on these trends. While this can be appealing, there’s always the risk of falling into a FOMO mindset, much like Black Friday shoppers.

When investors let the fear of missing out drive their decisions, emotions often cloud their judgment. As a result, they may end up buying into passing fads or overpriced stocks. Here, it is worth remembering the phrase that Benjamin Graham (author of The Intelligent Investor) coined:

"The investor's chief problem, and even his worst enemy, is likely to be himself."

Asset management is based on the idea that the future is somewhat predictable. However, the appeal of a good story doesn’t always translate into good investments. That said, thematic investing still holds merit and shouldn’t be dismissed too quickly.

The best definition, I've found, is from Pictet Asset Management.? They state:

"the primary purpose of a thematic equity strategy is to invest in stocks whose returns are influenced by structural forces of change that evolve independently from the economic cycle."?

Investing in a particular enduring structural theme sounds simple, but translating thematic trends into consistent excess returns is no easy task. To resist the powerful "FOMO" urge to invest in a thematic fund, ask yourself the following:

(a) Are there attractively priced companies benefiting from favourable multi-year thematic trends?

(b) Will you be actively aligning your capital allocation with these themes / trends to deliver superior investment outcomes?

Given the inevitable ups (irrational exuberance) and downs (irrational despondency), investing in thematic funds and ETFs must be a deliberate, active decision.

Don't arrive too late to the party - and never stay too long: So far, thematic funds have tripled their share of global equity fund assets in the 10 years to mid-2022 (according to Morningstar, April 2023). Three themes account for over 60% of equity sector fund asset under management; namely, technology, ecology, and healthcare (Morningstar, Sept 2023).

Yet, lots of talk about "mega-trends" can distract investors from a need to understand the underlying complexities of narratives. Themes change. And funds investing in the same theme can be radically different. That's why investors need to be thoughtful around how themes quickly evolve and when to buy into / sell out of stocks grouped around a theme. This sounds obvious, but is never easy to do in practice.

In their recent paper, “The Big Shortfall” (Nov. 15, 2023), Morningstar Manager Research observe: “Investors in thematic funds lost more than two thirds of total returns because of poorly timed buys and sells.”? While thematic funds’ average total return was 7.3% annualised over the five-year period through June 20, 2023, investors earned only a 2.4% return when the impact of cash inflows and outflows is considered.? Interestingly, the “return gaps were far wider in ETFs than in thematic mutual funds.”??

Slick narratives drive sentiment and expectations: Appealing (simple) stories about change (sometimes, but not always, backed by strong prior performance and social proof) lures capital. Inflows follow performance. Yet, we know that a trend is your friend - until it ends! I cannot deny the appeal to invest in thematic funds, but translating a trend into superior long-term investment returns requires outstanding investment skills.

To be clear, nobody wants to miss out on positive performance in fast-moving areas of the marketplace, but the longevity and valuation of a trend must be questioned.? As investors, we may underestimate future uncertainty and fail to consider the result of more capital chasing "in-vogue" stocks is diminishing returns.?As ever, do seek evidence of an actual alpha opportunity, do manage risk effectively, and do remain humble about your ability to know the future.

Why this matters: Themes, fads and hypes are not the same. Not every investor has the skills or crystal ball to foresee sustainable investment trends (aka themes), as well as an expertise in alpha generation. For fund buyers, benchmarking and comparing different thematic funds can be challenging. Themes (and the composition of thematic funds) evolve, therefore you need to watch the sunset of themes. This means adopting either a dynamic allocation approach to thematic investing or a multi-theme portfolio construct to avoid being "boxed-in" by a too narrow theme that has become too fashionable and over-valued; there is a question of valuation and sell discipline here.?

This means you need to be aware of your FOMO tendency, your confirmation bias, and your anchoring bias to themes. You must be able to tune out the noise, check the facts, and be damn selective with what you buy whenever you’re tempted to rush headlong into a new thematic fund or ETF... or into Black Friday.

But wait, what was Domino's Black Friday Deal… I’m off to order some pizza.?

Care to join me?

Until next time,

Chris Elsmark

November 21st, 2023

Thanks for reading. I'm always pleased to hear your thoughts and feedback. Catch up on past editions of the newsletter?on www.assetcircle.com

Further reading:

The Big Shortfall (Nov. 15, 2023), Morningstar Manager Research

Important Information | This publication contains general information only. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. And it does not constitute investment advice or any recommendation to buy, or sell or otherwise transact in any investments. Before making any decision or taking any action that may affect your business or investments, you should consult a qualified professional advisor.

Mark Andrew Smith David Saab Sébastien Gyger, PhD, CFA Frances D’Alessio Charles-Henry Monchau, CFA, CMT, CAIA