By LARRY SWEDROE
In his 1998 paper, Do Investors Trade Too Much? (the answer was yes for retail clients of discount brokerage firms), Terrance Odean noted that investors tend to limit their searches to investment alternatives that capture their attention and choose from a significant set of investment alternatives when they make purchases.
Odean and co-author Brad Barber have done extensive research on the performance and habits of individual investors. Among their findings is that, on average, individual investors lose money from trading — and not all the losses can be explained by trading costs.
In their 2008 study, All that Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors, they made the case that limited attention prevents retail investors from considering all available information and possible stock choices. Instead, many retail investors choose stocks to buy from the subset of stocks that catch their attention. Because most investors own only a few stocks and do not sell short, limited attention plays a smaller role in their sales decision.
Hong-Yi Chen, Hsuan-Chi Chen and Christine Lai, authors of the study Internet Search, Fund Flows, and Fund Performance, published in the August 2021 issue of the Journal of Banking and Finance, used the search volume index (SVI) provided by Google Trends as a direct measure of investor attention to explore the connection between attention-grabbing information and fund flows. They also investigated whether investor attention affects future fund performance and the survivorship of new funds.
To gauge investor attention, they constructed a measure of abnormal SVI (ASVI) for each fund by taking the difference between its SVI and its median SVI. Investor attention can be a result of tangible market efforts of fund families, changes in Morningstar or similar ratings, or intangible factors such as word of mouth or online “buzz.” Their data sample covered the period January 2004-April 2012. Following is a summary of their findings:
Investors often engage in purchasing new funds that have captured their attention online — new funds with higher ASVIs attract more fund inflows, supporting the attention-grabbing purchase hypothesis.
Fund investors who conduct internet searches and make attention-driven purchases are less sophisticated and fail to allocate their capital for earning abnormal returns — the correlations between fund flows and both returns and risk-adjusted returns are either negative or insignificant.
Compared with new funds without SVI, new funds with SVIs have more net fund flows, higher expense ratios and loads, higher incubation rate, and larger fund size and fund family.
ASVI is significantly associated with prior fund performance (the return-chasing behavior of unsophisticated investors) and the SVI of the fund family.
While investors tend to purchase funds that highly attract their attention, they do not redeem funds that draw less attention (the endowment effect).
Attention-induced inflows can help sustain new funds in competitive fund markets.
Similar to the results for new funds, the results for old funds support the attention-grabbing purchase hypothesis.
Old funds with more internet searches also tend to experience worse future performance — more attention-driven fund flows fail to predict better performance for old funds.
Their findings led Chen, Chen and Lai to conclude: “Investors cannot generate superior fund-related future returns when they exclusively follow online buzz and associated suggestions.” They added: “Our findings tend to suggest that more online searches induce more cognitive dissonance and thus more attention-driven purchases. Because unsophisticated investors are likely to overweight the accuracy of their predictions, the future performance of investments motivated by attention are less likely to be superior to that of the market or of other funds with the same objectives.”
The above findings are entirely consistent with those of the authors of the November 2020 study Attention Induced Trading and Returns: Evidence from Robinhood Users. For example, among their findings were that Robinhood users are more subject to attention biases and more likely to chase stocks with extreme performance and volume than other retail investors;Robinhood herding is influenced by information that is prominently displayed on the Robinhood app; Robinhood herding can be forecasted by attention measures, such as lagged absolute returns and lagged abnormal volume, previously shown to affect the buy-sell imbalances of retail investors; and Robinhood herding episodes are followed by abnormal negative returns.
Investor takeaway
The takeaway for investors is to stop paying attention to what is almost certainly just noise. You are best served by building a globally diversified portfolio that reflects your unique ability, willingness and need to take risk, and staying the course, rebalancing and tax managing as events dictate.