The evolutionary journey of investing as we have come to know it

In 1949, when Alfred W. Jones came up with an idea that became the first hedge fund as we know it today, he was simply executing an innovative strategy at the time of buying stocks and hedging the positions with short sales. It was considered a revolutionary idea in early 50s, and the markets didn’t really take it that seriously.

Today most hedge funds to tend to be unregulated investment pools that can only issue securities privately to qualified and sophisticated investors. And over time the industry has transformed itself into a behemoth, controlling over US 3.1 trillion in global assets. That’s bigger than the GDP of Canada or India. The success of the industry has turned some hedge fund managers into rockstars with the ability to move the market through their trade positions.

Traditionally financial markets have been fully controlled by Wall Street and the rockstars who operate within the ecosystem. But in the past few weeks, we have seen the power of social media, where the collective force of a community enabled by a cult figure head has change the dynamics somewhat. Obviously there is also greed at play, people looking to create rapid short term profit, and the addictive gamification of the markets by investing apps like robinhood. Also the urge to push back against the Wall Street and the status quo, are all forces coming together from various directions to form what could possibly be described as a perfect storm.

The start of the year 2021 couldn’t get more interesting for Wall Street and the markets. People are informally forming a band together on social media platforms to push a stock up without any fundamental basis for a specific stock to go up by 275% in a matter of a week. But I will be quite hesitant to confuse it as a battle of people versus Wall Street. There is more at play here, and I wont be surprised if sophisticated hedge funds have somehow managed to embed themselves as part of the community pushing the stock higher to counter their rivals short position on a specific stock. Hedge funds are quite capable of deploying any legal tools available in their armoury. It is one of the reasons why some hedge funds have been so successful over the years.

Having said that, there is surely a sign of people lead revolution in motion as a push back against the Wall Street. And the cult figure heads at odds with Wall Street will continue to fuel the fire against the status. So for them the fight is very personal. And this approach has had some success, just look at companies like Tesla with a promoter who is now clearly a cult figure head with a large fan following, willing to back their guy at all cost. If the collective decides something has staying power and the cult figure heads are willing to endorse it then that asset class will continue to carry momentum powered by a trend. That has been the case for assets like Bitcoin.

You could rightly argue that investing in today’s age has become mostly about momentum and trend, driven ny human psychology and sentiments. Stock market now looks like a spectators sports with similarities to WWE ( wrestle-mania ), disconnected with the reality. The society is clearly changing, you have personality driven politicians getting elected, and people seem to care less about policies. And looks like the same applies for business also. The ability to enlist your fan base to a cause is a very powerful tool to have in your hands. No wonder why Mr Trump feels he owns the Republican Party, because his entire fan base is now married to him.

Then you have business personalities like Mr Musk who feel immensely empowered because of his fan base. But I must add, Wall Street wasn’t kind to him, so in my view his fight with Wall Street and the establishment looks quite personal. For decades now Wall Street has had too much power over companies and the economy. And in his fight against Wall Street Mr Musk’s fan base has delivered for him, just look at Tesla’s stock performance, and his ability to move the markets with a tweet.

Human psychology plays a key role in what happens to the market and how people invest, and it looks like this is how some people want to invest now. It’s the new age of tech savvy “ couch investors “ empowered by fintech platforms helping people to band together and then turn their investment into a revolution. And at least for now it’s working. So now in some cases, all you need is a tweet from a champion influencers with large fan base to push a stock up. Thereby making the life of analysts quite tricky. They might as well go on holidays. Fundamentals seems to not matter to people. You could probably conclude that their investment approach is, live fast and die young. That seems to be the trend, and its probably here to stay. But let’s see.

Large institutional investors and the regulators need to realise that the revolutionary couch investors are real, and they organise on social media platforms to collectively push a stock they like or prefer, and mostly they are picking a company that Wall Street doesn’t like. Take for example Tesla a couple of years ago. That’s why I don’t really worry about what analysts have to say about specific stock, what happens to a stock now depends on what people in Reddit, discord and other chat rooms etc are planning to do as community. And my guess is that sophisticated hedge fund have most likely embedded themselves into such communities to create an edge for themselves.

What we shouldn’t forget is that, while institutional investors have managed to get bailed out by governments through various bailout packages. And while billionaires have kept getting richer, common people have been left to fend for themselves, by and large. So it’s understandable why common people with some support will now be striking back against Wall Street pros, who have had control of the financial markets for decades. But there are also shady forces at play here too. I won’t be surprised if some hedge funds are now quite well plugged into so called collective.

So now you will a younger generation of investors playing stock markets as they do gaming. I have been watching the social media space for almost a year now, and I have seen the evidence of the strong resolve of these revolutionary investors. They decide the valuation and go for it, and they are a force to be recon with, never mind their understanding of the market. The rules of the market don’t apply to them. I am curious to see how SEC and other regulators will now react to this new potent force “ the revolutionary collective”, and how will they police any potential market manipulation ? Whatever happens from here on, I believe institutional investors and regulators will probably need to concede that, a new force is establishing itself.

Going forward my sense is the markets will crash at some point. The frothy bubble at the top will burst, and people will lose money, but this potent force of collective revolutionary investors is probably not going to go away. Just take a look at Bitcoin and why people say it has staying power. Personally, I consider all this gambling, but to a younger generation that grew up on gaming, investment is no different than gaming. And maybe, the new reality is here to stay, so therefore, markets will have to adjust to the new reality.

Investment platforms like Robin Hood added features have transformed trading into gaming. It has brought a large number of smaller retail investors to the market, and in the process it made a lot of gamblers rich and many more gamblers very poor. During the pandemic related lockdown a larger number of first time investors have taken to platforms like Robin Hood to trade markets, sometimes just for fun.

Almost half of the users of Robin Hood started out as first time investors, and are therefore, more likely than traditional qualified investors to be influenced by attention or recommendation from others, so their investment behaviour tends to be more correlated, and therefore, the investors active on Robin Hood are more likely to act in a herd set up than other traditional investors.

I have been expecting Robin Hood to become a victim of its own success, and it is probably heading in that direction. The platform like any social media app is designed to be easy and addictive, so people active on Robin Hood are very likely to become a day trader, which will create volatility, and make the trades more disconnected with the real economy.

As a curious person, I have been watching the evolution of Robin Hood and cult figures like Mr Musk, and I am quite curious to see how this landscape will evolve going forward. I have a masters in finance and also a degree in economics, but do I understand finance or economics? The answer is no! And I am increasingly becoming convinced that everything we know about economics as a subject is wrong. Economic theories no longer operate the financial markets. Investing has clearly evolved over time, and we are most likely witnessing the evolutionary change in how people will invest and how much control Wall Street can exert over the markets going forward. So let’s see where we end up.