Morningstar - Q2 2021 - 12

Dispatches

do those with long positions. Investment
hype flies in both directions. (Elon Musk attacks
short sellers but not those who predict grand
achievements for his company.)
Nor should hedge funds be regarded as villains.
In truth, that charge is difficult to understand.
Ultimately, it seems, the belief arises more from
symbolism than from actual events. The
problem is not crimes that hedge funds have
committed-such as overcharging their customers
while underperforming the stock market-
but instead what they represent: Wall Street at
its most privileged and coddled.
If there is a bad actor in these proceedings,
perhaps it is the WSB investors themselves for
disrupting the stock market. Some observers
have advanced that very argument. The headline
of an editorial in The Washington Post read,
" The Good Guys in the GameStop Story? It's the
Hedge Funds and Short Sellers. " For its part,
Bloomberg opined, " GameStop Mania Is Delivering
a Dangerous Rush to the Reddit Mob. "
I disagree. Ultimately, neither the motives of
WSB's readers nor their methods deserve criticism.
If GameStop's buyers invested for personal
reasons as well as pecuniary, that is their right.
The stock market does not test investor
intentions. And if those trades were legal, as with
the GameStop purchase, it is nobody's fault
if the market wobbles. If the regulators perceived
a problem, then they can devise a solution to
prevent its reoccurrence.
All of this is to say that the stock market's
workings are purely business. Whether participants
are motivated solely by the wish to make
money or have other desires is immaterial. Those
who bought GameStop were not nobler than
those who had sold it short. Neither, however,
should their behavior be blamed.
Not Rigged

Underlying GameStop's rally, as well as
those of other fashionable purchases, including
Tesla, Peloton, and bitcoin, is the belief
that Wall Street is rigged against common
investors. For various reasons, these
assets are viewed as being outside the system.

12

Morningstar Q2 2021

They appeal to those who wish to tear down
the house.
As with Occupy Wall Street and the Tea Party,
two overlapping political movements that
drew from each side of the spectrum but shared
a disdain for the Wall Street establishment,
this investment rebellion cuts across party
affiliations. U.S. Sen. Josh Hawley, R-Mo., attacks
hedge funds, and so does Sen. Elizabeth Warren,
D-Mass. Birds of a feather.
For those of us who have spent our careers
following mutual funds, the sentiment
is difficult to understand. Mutual funds and their
younger siblings, exchange-traded funds,
are thoroughly populist investments. Their
performances are comparably calculated, their
portfolios publicly posted, and their costs
uniformly assessed. All investors within a given
share class receive the same treatment.
As a result, fund shareholders typically receive
what they expect: a portfolio that reliably
tracks an investment marketplace. This statement
obviously describes index funds; for example,
Vanguard 500 Index VFINX gained 13.72%
annualized for the decade ended Dec. 31, 2020,
as opposed to 13.88% for the benchmark
itself. But it also holds for most actively managed
funds, especially the larger ones, which tend
not to stray far from the index's performance.
Matching the overall marketplace, by definition,
is not losing a rigged game. Nor is lacking
the opportunity to own hedge funds. The 10-year
return for Eurekahedge Hedge Fund Index,
through Dec. 31, 2020, was 5.2% annualized. That
performance not only sharply trails that of
Vanguard 500 Index, it also lags the result for
each of Vanguard's target-date funds.
Quite literally, an employee who doesn't even
realize that he owns a 401(k) account-that is, one
who was defaulted into a Vanguard target-date
fund upon joining the company and who never
checked the paperwork to realize that his paycheck
was being docked-would have earned higher
profits over the past decade than the typical hedge
fund investor. How is that drawing the short
end of the investment stick?

Equities for All

Those who invest in stocks directly also
fare well. Thirty years ago, retail brokerage
commissions were well above those
paid by institutional investors. Today, those
commissions either are explicitly free,
as with Robinhood and those competitors that
have matched its offer, or effectively so,
as with the remaining discount brokers, which
levy only a nominal fee. The barrier
that commissions once placed between
retail and institutional investors has
been removed.
What's more, everyday investors often pay lower
spreads on their stock trades than do the
institutions. This occurs because market makers
would rather conduct many small trades,
which tend to cancel each other out, than a few
big trades, which might skew in one direction.
Besides, large bettors might know something that
market makers do not. For these reasons,
market makers will frequently reduce their prices
for retail transactions to entice brokers to
send those orders.
(The same logic applies to bookmakers who accept
sports bets. Better to receive 1 million wagers
of $10 than 10 wagers of $1 million each.)
Finally, information for retail stock investors has
never been more freely available, thanks to
advancements in technology and communications.
Nor has trading ever been so accessible.
No longer must retail investors await stale copies
of printed research reports that circulated
through Wall Street days ago or call in their
requests for stock trades via the telephone. Review
an electronic feed here, open a page there, click,
and be done. As the professionals do.
Few retail investors short stocks, which is a
credit to their intelligence, since most short trades
flop. Over time, stocks tend to rise rather
than fall; borrowing costs for short positions can
be steep; and unlike with a long purchase,
there is no theoretical limit to the potential loss
of a short position. Shorting is a mug's
game, which is why almost all shorts do so while
hedging long positions, rather than as a
solo endeavor.
Morningstar - Q2 2021

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