Morningstar - Q3 2021 - 8

Dispatches
Crypto Frenzy
Before diving in,
consider, what's
your edge?
Phillips Curve
10
The Smithy of the Soul of Capitalism
Ivory Towers
12 How Many Stocks Beat the Indexes?
Policy
16 Does Compensation Affect Advisors'
Advice on Funds?
Sustainability Matters
17 ESG Critiques Often Miss the Mark
DEI
18
The Case for Real DEI in Your
Advisory Business
21
25
Global Briefs
Americas
Greater Europe
28 Australia & New Zealand
LETTER FROM THE BOARD
Dan Kemp
Cryptocurrency is an increasingly dominant
topic of conversation in the reopened pubs
of the Square Mile and the bars near Wall Street
as professional investors try to understand
whether it is a genuine asset class
or simply the latest in a long list of high-octane
financial irrationalities.
As long-term, valuation-driven investors who
take the stewardship of our clients' capital
seriously, it is tempting to ignore the convulsions
occurring in one corner of the capital markets
and focus our attention and resources on
assets with more predictable outcomes. However,
experience has taught us that excess in one
part of the capital markets can metastasize,
having an impact on all investors and, therefore,
cannot be ignored.
When tackling these situations, it is often
useful to look at similar episodes in history in
an attempt to learn lessons that will benefit
our decisions in the present. It is, therefore, with
perfect timing that William Bernstein has
published a new book, The Delusions of Crowds:
Why People Go Mad in Groups (Atlantic
Monthly Press). As a neurologist and investor,
Bernstein is interested in the way we make
investment decisions, and the The Delusions of
Crowds recounts the more serious religious
and financial manias and movements over the
past 500 years.
Characteristics of Market Frenzies
Against this backdrop, the current enthusiasm
for cryptocurrencies and related technology
8
Morningstar Q3 2021
companies appears rather tame. Yet it
bears many of the hallmarks of these historical
episodes: the advent of a new technology,
the support of low interest rates, a rapid
increase in supply (according to CoinMarketCap,
the total value of cryptocurrency reached
a recent peak of more than $2.2 trillion,
up from $243 billion a year ago), a disregard
for traditional asset valuation principles,
and a separation of society into those who
" get it " (recall the " laser-eyes " social
media profiles) and those who don't, with
the former resulting in the creation of
echo chambers and self-reinforcing loops
of belief.
Given these similarities, historical market
frenzies can provide several important lessons for
investors in the current environment that
are equally relevant to those on the " inside "
or " outside. "
First, market frenzies can persist and grow for
longer than seems reasonable because
they are fueled by stories of people who have
made huge sums of money. Such stories
tend to draw more people in until the frenzy
collapses under its own weight, resulting
in a redistribution of wealth between those
who sold early and those who bought late.
Second, the apparent availability of wealth
acts as a strong incentive to poor moral
behavior. So, we should be vigilant to the potential
for fraud, which is typically only discovered
after the event.
Third, the existence of market irrationalities does
not preclude the possibility of significant
financial gains for some long-term investors and
benefits to society as a whole. While the
railway frenzy of the 1800s ruined many investors,
the resulting infrastructure development fueled
long-term economic growth in the United Kingdom
and United States.
Similarly, the dot-com bust ruined many
investors but promoted the technology that has
allowed many of us to continue to be both
productive and in touch with our families while
at home over the past year.
https://www.morningstar.com/authors/2076/dan-kemp
Morningstar - Q3 2021

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