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Bubble mutual funds

Summary:
Over the last decade, I’ve done numerous posts explaining why the bubble hypothesis is not useful. The bubble hypothesis claims that asset overvaluation is often “obvious” in real time, and implies expected future underperformance, on average. I’ve also argued that the lack of successful “bubble funds” is an indication that asset price bubbles do not exist. If they did, then mutual fund managers would be able to outperform the market by taking short positions in a wide variety of assets experiencing a price bubble. In 2017, Joe Weisenthal had an amusing idea for a contrarian investment: [B]ack in 2017, I did joke on Twitter that someone should create a portfolio consisting solely of assets that pundits love to warn are in a bubble. The premise was that people

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Over the last decade, I’ve done numerous posts explaining why the bubble hypothesis is not useful. The bubble hypothesis claims that asset overvaluation is often “obvious” in real time, and implies expected future underperformance, on average. I’ve also argued that the lack of successful “bubble funds” is an indication that asset price bubbles do not exist. If they did, then mutual fund managers would be able to outperform the market by taking short positions in a wide variety of assets experiencing a price bubble.

In 2017, Joe Weisenthal had an amusing idea for a contrarian investment:

[B]ack in 2017, I did joke on Twitter that someone should create a portfolio consisting solely of assets that pundits love to warn are in a bubble. The premise was that people always call things that have gone up a lot a bubble, and most of the time those calls are wrong (or at least very premature), so it makes sense to buy them all as a basket.

It turns out that someone took his advice:

Paul McNamara, who runs an actual nonpretend hedge fund at GAM, went ahead and constructed a hypothetical bubble portfolio a few days later, consisting of things such as Netflix, Tencent Holdings, Tesla, a Canadian apartment REIT, a London property company, the Grayscale Bitcoin Trust, the Argentine century bond, Japanese government bonds, long-term zero-coupon U.S. Treasuries, and so forth—you know, all the things people have been calling overvalued for years. Some of the positions have blown up (thanks, Argentina), but by and large, performance has been robust.

Note that this portfolio is the opposite of what I proposed.  I suggested a fund that took a short position on “bubble” assets, whereas McNamara’s hypothetical portfolio took a long position.

Suppose I am wrong, and that mutual funds taking a short position in bubbles really could systematically outperform the market.  In that case, those funds would become very popular and this would quickly tend to move asset prices to their correct level.  So even if the bubble hypothesis were ever to become “true”, its validity would only last for a brief period, before being competed away by greedy investors.  Bubbles would last as long as a child’s soap bubbles blown into hurricane winds.

Bubble mutual funds

Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment". In May 2012, Chicago Fed President Charles L. Evans became the first sitting member of the Federal Open Market Committee (FOMC) to endorse the idea.

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