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Social Investing and Market Psychology

Some of this summer’s events provide interesting hints about the potential pitfalls of
social investing. Market neutral hedge funds (e.g. Goldman Sachs Global Alpha fund was down 23% for
the month of August) went down in flames when they tripped upon themselves
trying to unwind highly levered bets in illiquid markets that had turned sour.
Absolute Capital has lost 90% of its value over the last month, while its
portfolio of penny stocks has become worthless.

Social investing sites, such as Cake Financial and Covestor, offer a distinct
advantage over other investment forums and blogs, by enabling users to build
their reputation based on their actual performance. This capability, although
it represents a real improvement, should be taken with a grain of salt. Absolute
Capital, for instance, has demonstrated superior performance year after year,
as evidenced by its multiple awards.

Obviously, when the market trends upward, an asset’s illiquidity provides an added performance
boost. Investors that focus too much on past performance and mirror others’
trades - as enabled by social investing sites - could end up reinforcing unhealthy trend, unbeknownst to them. However, when the
market turns south, their losses could pile up very rapidly.