Death of an ETF

Brit Ryle

Posted November 29, 2023

I’ve never been a particular fan of ETFs. Not that there’s anything inherently wrong with buying a group of stocks that target a particular sector or index…

After all, S&P 500 Index Funds pretty much underpin America’s entire retirement savings system. And these funds have proven to be an effective way to grow your money with about as little risk as it’s possible to get from any investment. 

Of course, by definition, you’re not going to outperform the market with an S&P 500 index fund. The whole point of diversifying is to throw a wide net, have the good outweigh the bad, and let the S&P 500s historical 8-10% average annual gain carry you to retirement glory. 

Personally, I prefer a more concentrated approach to investing – finding a few top quality companies to do the heavy lifting. But then, I have the comfort of following the market all day every day…

There’s a sizable portion of the ETF market that is devoted to what we might call “thematic” investing. There are robot ETFs, there are dividend ETFs, crypto ETFs, country ETFs that target China, or Mexico, etc. 

Cathie Woods ARK funds’ fall into this category. 

Nothing inherently wrong with targeted thematic ETFs, either – except that every time some new investment theme hits the headlines, like AI, for instance, a bunch of ETF companies will launch a bunch of AI stock ETFs and peddle them to unsuspecting investors. 

These ETFs are not designed to make you money. Not like an S&P 500 ETF. Many ETF companies launch ETFs to take advantage of investors enthusiasm for a headline-making investment theme. The idea of an ETF carries with some assumption of diversification and safety, but that often isn’t the case, at all…

Because if the theme underlying your ETF is crap, it doesn’t matter how many related stocks you put in there, they’re gonna be crap too. 

Like with the Roundhill MEME ETF (MEME).

A MEME Stock is Born…

I just learned this morning that the Roundhill MEME ETF is slated for liquidation on December 11. I’m not even sure I knew it existed in the first place – it’s not the type of thing I’d pay much attention to…

Now I don’t know if you remember the whole meme stock phenomenon from a couple years ago. It started with a bunch of people on a stock trading message board at the Reddit website deciding to try and get a short squeeze going on a heavily shorted stock. 

If you don’t know, a short position is a way to make money as a stock price declines. Find a stock that you think is overpriced, and you can borrow shares on the open market, sell them, and buy them back at a lower if/when the stock price falls, and pocket the difference. 

The thing is, a short position is based on borrowing. You have to have a margin account with your broker, meaning that the broker is lending to you. And there is always a limit as to how much they will lend you. 

Say you short a stock at $10, thinking it will go lower. Instead it goes to $11. If you have cash in your account, or other stock holdings, you’ll probably be ok. If you don’t, your broker might require you to deposit money into your account to cover the loss. This is a margin call. 

Now if that stock goes to $12, the problem could get bigger. $13, $14 – if you can’t add cash, your broker has the right to sell your other stock holdings to cover the loss. Now you have less asset value to cover the margin loan and the broker might keep selling more of your stock if the losses get worse…

This can really snowball because when the broker is covering your losses on a short position, it means the broker is buying back the shares that you shorted at higher and higher prices. This is a short squeeze. Getting out of a short position means buying the stock, which can push the price higher. And in a short squeeze, the shorts are literally being forced to buy at higher and higher prices – it can really get out of hand…

So, the first meme stock was Gamestop (NYSE: GME). Its business model was buying and selling used video games when they were issued on CDs. Kids loved it. But as video games went on line, the flaw in the business model was obvious. There was no doubt it was just a matter of time before the company went bankrupt. And Gamestop became one of the most heavily shorted stocks of all time…

Hedge funds sold billions of dollars worth of Gamestop stock, and were just waiting for the stock to move lower – which it did consistently for years between 2016 and 2020.  It was a slamdunk trade, fish in a barrel.

Except for that bunch of individual investors who got the idea to kind of pool their money and buy a whole bunch of Gamestop shares to push the price higher and maybe stick it to the hedge funds really was kind of genius. There’s no way those people from Reddit could have known just how successful their little scheme would be…

Starting in January 2021, shares of Gamestop ran from $17.25 to $125 a share in a span of about three weeks. One hedge fund reportedly lost $19 billion and had to shut down. All because of a group of people on a Reddit trading/investment message board, some of whom made millions…

Good Riddance

So, individual investors tried to duplicate the Gamestop success with other MEME stocks. The movie theater company AMC (NYSE: AMC), former smartphone company Blackberry (NYSE: BB), even Bed Bath and Beyond had a moment as meme stock as it confronted bankruptcy. 

And there was some success, though nowhere near what happened with Gamestop. My son actually got in on the Bed Bath and Beyond squeeze. I know somewhere in my text history, there’s an exchange between us where he’s doubled his money in two days, and I say “Maybe Sell,” he says “Nah it’s going higher”, it doesn’t and I say “Why do you hate money?”

A bunch of people getting together on a message board is one thing, kinda cool. But I honestly don’t know how an ETF company like Roundhill ever got regulatory approval to launch a MEME stock ETF. It’s a pretty obvious attempt to take advantage of individual investors. 

I checked out the Roundhill website. Gotta say, I’m not impressed. As for their other ETF offerings, there are 13 surviving. 4 of them have $1.2 million or less under management, not sure how long those will last. 

Roundhill’s expense ratios aren’t as bad as I thought they’d be – the highest is 0.8%. 

Still, I’m wary of any ETF that seems more targeted toward the headlines than actual performance…

That’s it for me today, take care, and I’ll talk to you Friday…

Briton Ryle
Chief Investment Strategist
Pro Trader Today
brit.ryle@protradertoday.com
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