I’m fairly sure that when most readers, especially those of a professional background, read about plans for Roundhill’s new MEME exchange-traded fund, they probably either sighed, rolled their eyes or laughed out loud – or maybe a combination of all three. Words like ‘faddish’ might also have been lobbed around.
But I’m not quite so sure that the cynicism is warranted. In fact, I think it might actually be an inspired idea. Perhaps it captures an elemental truth that professional investors struggle to acknowledge, which is that in our ‘new normal’, fundamentals might not matter as much as they used to.
Let’s back up. The mooted ETF, which still requires regulatory approval, will track an index made up of stocks trending on social media, which is called the Solactive Roundhill Meme Stock Index. As for the meme stocks in the portfolio, I’m fairly sure we know all the likely names by now. But the index also apparently has a nice twist in there, which is that might also have a screen for short interest, with the index components of MEME rebalanced every two weeks.
This isn’t the first stab at this kind of momentum-on-steroids strategy. The VanEck Vectors Social Sentiment ETF (BUZZ), backed by Barstool Sports founder Dave Portnoy, invests in stocks that are popular on social media, while FOMO is an active ETF from Tuttle Capital Management that ‘seeks to track companies with high social media sentiment, as well as special acquisition companies and cryptocurrency companies.’
In truth, what we seeing here is good old-fashioned momentum factor investing, but with social media metrics playing the role classically reserved for technical analysis. Another way of making the same point is that social media has allowed for an effortless implementation of traditional momentum ideas.
Many moons ago at one of the big ETF events, I watched a presentation in which the always-illuminating Rob Arnott explained why momentum was the great factor premia that never quite played out as expected. On paper it seemed to work, but in reality it was never really implemented very well. I asked Arnott why that was the case, and his response was that it was difficult and costly to implement on a systemic basis.
Well, I’m not quite sure that is true anymore. The first chart below shows recent returns for the big iShares momentum factor ETF (AUM: $15bn). I’ve compared returns (in black) against the plain vanilla MSCI USA index (blue) and also the S&P 500 (red). I’d say that the iShares momentum ETF has done a pretty damned good job overall.
But if we dig around inside the fund’s components, we’ll see a few surprises. The top holdings include names you’d expect to see, such as Tesla (5.9%), as well as less predictable outlets like Disney (4.4%), JPMorgan (4.3%), Berkshire Hathaway (4.1%), and Bank of America (3.9%).
The point here is that this is a narrow definition of momentum, hedged in by liquidity requirements and market cap rules. The joy of social-media-based ETFs is that you are seeing a more diverse, more ‘modern’ definition of how markets allocate capital in the age of Robinhood.
Academic support
Now the hardened professional cynic might at this point accept that all this momentum stuff is interesting – but add that it only ‘works when it works’ and fails miserably in down markets, making it impossible to actually implement in a client’s portfolio.
But various academic studies – most recently by finance profs at a UK business school that used to be called Cass – have shown that a simple market timing strategy combined with momentum can deliver fantastic returns. Using the 20/200 day moving average cross-over idea, you alternate between full-on momentum as opposed to cash or Treasuries. When the 20-day MA moves below the 200 day MA, you sell the momentum ETF and buy the boring stuff. Job done.
Still, a questions remains. Momentum may work, but why? Why are markets behaving in this way?
This brings me nicely – with a hat tip to economist Tyler Cowen – to a cracking new paper by Xavier Gabaix and Ralph Koijen. These economists have very been slightly confused by what it is that actually moves markets and stock prices. Is it the pure random walk, deep fundamentals such as Robert Shiller’s CAPE measure, or is there another force at work at the level of the aggregate stock market?
Their key conclusion is, I think, devastating. They find that the ‘the price elasticity of demand of the aggregate stock market is small, and flows in and out of the stock market have large impacts on prices… we find that investing $1 in the stock market increases the market’s aggregate value by about $5.… The mystery of apparently random movements of the stock market, hard to link to fundamentals, is replaced by the more manageable problem of understanding the determinants of flows in inelastic markets.’
That word ‘flows’ is absolutely crucial. What powers markets are flows (and investors subsequent adaptive behavior) and what powers flows are institutional preferences on behalf of clients which favor equities and especially growth equities. The logical extension is to put flows expressed as momentum at the heart of the strategy.
There’s another benefit to utilizing this approach. If you don’t, you’ll face lots of ‘hey advisor, why haven’t you been putting my money into Tesla [or another growth or meme stock] like my friends?‘ questions from clients. And they might actually have a point.
I’ll conclude by paraphrasing Gabaix and Koijen. What’s powering markets is a relentless money pump of fund flows into growth equities, which is spun into momentum by short-term-focused investors. In that new financial order, fundamentals don’t really matter so much, but social media attention and meme stocks do.
So what’s so funny about the MEME ETF?