Smart companies are increasingly embracing the crowdsourcing trend. Businesses are using crowdsourcing to help with just about everything including assessing consumer preferences, determining which new products to launch and assisting with broad marketing efforts. So it makes sense that an ETF would soon begin crowdsourcing its investment ideas.
The CrowdInvest Wisdom ETF (NYSEARCA:WIZE) is a smart beta fund founded with the notion that the overall sentiment of the universe of otherwise independent investors can outperform active money managers and the underlying indices. On the CrowdInvest website's home page is the quote, "Under the right circumstances, groups are remarkably intelligent, and are often smarter than the smartest people in them."
Here's how it works. The creators of the CrowdInvest Wisdom Index look to select and balance a total of roughly 35 stocks that are based on the bullish and bearish sentiment of users of the CrowdInvest mobile app. Users simply click on the bull or bear symbol on the app for each stock they follow and the ones with the most positive net sentiment make the cut for the portfolio. Josh Brown at the Reformed Broker called it "Tinder for stocks".
One of the fund manager's criticisms of the actively managed fund universe is that "approximately 70% of mutual fund managers of US domestic actively managed mutual funds and ETFs underperform their benchmarks and charge approximately 1.50% a year in fees." While these two figures are mostly true, generally speaking, the CrowdInvest Wisdom ETF and its 0.95% expense ratio aren't much better. Despite this, the company boasts that its Wisdom Index outperformed the S&P 500 (NYSEARCA:SPY) by about 1.5% in the one year since its inception.
Given that most of the attention on the app is given to larger companies, this is primarily a large cap ETF. Top holdings in the fund include Allergen (NYSE:AGN), V.F. Corporation (NYSE:VFC), Oracle (NYSE:ORCL), Morgan Stanley (NYSE:MS), General Growth Properties (NYSE:GGP) and H&R Block (NYSE:HRB).
While it's a good start for the fund, it's tough to put too much weight into one year's performance, especially given the investing public's history of shooting itself in the foot. Studies have shown that the average investor return over the last few decades has been roughly 2% annually. This is in a time when the average annual return of the S&P 500 is over 10%. Saying that the sentiment of the investing crowd can beat active fund managers given this kind of historical track record makes it a dubious claim.
Investor sentiment tends to be a lagging indicator. Traders tend to buy stocks after much of the upside has passed and only sell after stocks have dropped. This kind of emotion-based trading is going to make it difficult for the fund to outperform over a longer time frame.
While the claim that high expense ratios deserve much of the blame for the failure to outperform an index is largely true, this fund's 0.95% expense ratio will soon catch up with it as well. Trying to simply match a broad market index is hard enough. Beating it by a full percent every year will be harder.
While this ETF is an intriguing use of the crowdsourcing concept, I'm leery of its ability to outperform over the long term. For now, I'm staying away.
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