Crowd-Sourced Investing: Read The Fine Print

Have you ever heard of CrowdInvest and do you regularly use its Apple iOS app? If you’re an investor, and you answer “No” to either question, as it seems many would, that raises troubling questions regarding the credibility of the index its pushing and of the CrowdInvest Wisdom ETF (WIZE) which was recently launched based on it.

The Idea

The index and the ETF track own respectively a portfolio of popular stocks, the 35 stocks that received the most net bullish votes (bullish votes minus bearish votes) from among U.S. listed firms that meet a basic liquidity requirement (average dollar volume traded over the last 20 days averaging $15 million or more).

Complaining about active mutual find manager performance and about the size biases of plain-vanilla index funds, CrowdInvest says it has a better idea. Inspired by James Surowiecki’s book The Wisdom of Crowds, it decided that portfolio’s selections be based on votes by the crowd, with position weightings determined by the relative strength of the bullishness of the vote.

On paper . . .

On paper, this idea sounds . . . this is where I’m supposed to say “good” or “OK.” But I won’t. On paper, this idea struck me as being bad. My inclination is to lean, for investment wisdom, to authorities such as Peter Lynch, who in his classic One Up on Wall Street, penned what has become one of my favorite passages:

“If I could avoid a single stock, it would be the hottest stock in the hottest industry, the one that gets the most favorable publicity, the one that every investor hears about in the car pool or on the commuter train— and succumbing to the social pressure, often buys.” (Kindle Location 2366 – sorry folks, I don’t do page numbers any more.)

I agree with CrowdInvest that active management isn’t so hot and that market cap weighted index funds aren’t ideal, and have so written Forbes. But null ; i.e. I work with rules-based models built using data to identify stocks worthy of consideration, not because the crowd says so, but because, objectively speaking, they really and demonstrably are worth owning. I expect anybody who has ever had any success in equity investing knows that the ideal is to get in before crowd figures out the stock is good, and preferably, even before the crowd figures out that it exists. And no, I’m not talking about penny stocks. The crowd can be remarkably narrow, and often focuses only on stocks media outlets think can garner enough eyeballs, (ad viewers) to justify exposure. There are many good-size companies with very liquid stocks about which the crowd knows zilch or which isn’t top of mind at the “right” time.