In backtesting back to 1980, Welch found that the portfolio constructed by this algorithm held its own against the overall market, and actually came out ahead according to some performance evaluation tests.
The wisdom of crowds
It’s hard to square Welch’s results with the narrative that the small retail investors on the Robinhood site are a pure expression of irrational exuberance.
That isn’t to say that there aren’t individual examples of such exuberance. For example, Welch found that, at one point in January 2019, stock of Aurora Cannabis
ACB, +0.63% was held in more Robinhood portfolios than was Apple
AAPL, +1.96% , even though Apple at the time had a market cap that was more than 100 times larger. Since the beginning of 2019, Apple’s stock has gained more than 190% while Aurora Cannabis’ stock has lost more than 90% (according to FactSet data).
Welch’s findings are an illustration that,
while not every investor is rational, the collective wisdom of the crowd is often superior. Keep that in mind the next time you hear a Wall Street guru insist that small investors who frequent platforms such as Robinhood don’t know what they’re talking about.
There’s a distinct possibility that, as a group, those small investors are doing better than the guru.
I note in this regard that Welch’s findings are consistent with those from
another study this summer, which used a different methodology to analyze the behavior of investors at the Robinhood site. That author of that earlier study found that
“Robinhood investors have been buying riskier stocks, but have also been performing slightly better than the market.”
I note that Robinhood in August stopped making updated data available that would enable the kind of research that was conducted by Welch. A spokesperson for Robinhood explained in an email that the firm did so because “the trend data could be reported by third parties in a way that could be misconstrued or misunderstood.”
News stories at the time suggested that Robinhood felt that third parties were making it appear that the company was “pandering to day traders.”
Yet Welch’s research suggests that Robinhood investors, as a group, are not the irrational thrill-seeking traders that some of these narratives would have us believe.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com
