Don't Follow the Herd

Over the past couple of years, the fear of missing out has led some smart money investors to overlook basic principles of investing and red flags. Instead, they have fallen in line with the prevailing groupthink embracing the flavors of the day, including meme stocks, certain SPACs and digital assets. While it was easy to make money in a market environment that benefited most asset classes, the uncertainty and volatility of the current backdrop brings a renewed clarity about the path forward, including a reset in mindset and a return to fundamentals which reward analysis and judgment, not fads and influencers.

The conviction of Elizabeth Holmes in January to the collapse of FTX last month serve to remind us of the power of herd mentality and anxiety about being left out. In both cases we saw some of the world’s largest and most successful investment firms throw caution to the wind and ignore risks that were hiding in plain sight. Some may have misjudged opportunities due to a genuine belief in the prospect of disrupting the status quo, whether in decentralized finance, democratization of wealth creation or the promise of a better, faster, cheaper methods of doing things. For others, it was the desire to seek out returns in an era of ZIRP. We saw pension funds and endowments increased their percentage of investments in alternative assets like private equity by 2x. The ubiquity of finance (ala Robinhood) and PPP/fiscal policy also contributed, creating a new class of less experienced investors dabbling in risky asset classes without adequate regulation and oversight. Yet, others seem to have crossed the line between identifying the next unicorn and trying to simply create one with generous investment. Taken together, these investors were caught up in the headiness of the moment. One of my panelist Susan Lyne, managing partner at BBG Ventures, noted there were some firms that were simply too big and too flush with cash chasing a finite number of deals. This may have led some later stage investors to foray into less proven earlier stage opportunities. Others, moving fast in pursuit of a transaction, simply failed to properly examine the data, evaluate governance and overpaid for deals.

Business is grounded in trust. Going forward, the lessons of Sam Bankman-Fried and Elizabeth Holmes should trigger a reset. My panelists acknowledged that due diligence and corporate governance – with an emphasis on board qualifications and independent board seats - are key. I would add to these the need for renewed rigor, access to information, realistic expectations of valuation and regulatory oversight. In a recent Bloomberg interview, the chair of the SEC, Gary Gensler, framed it as “disclosure and transparency versus darkness or opacity,” pointing specifically to the fact this is about market integrity. Thorough vetting by investors will not only prevent fraud but help restore trust.

Events in 2022 serve as a reminder that even the smart money can be wrong. If things seem too good to be true, they probably are. As we ease into 2023, the indiscriminate sentiment and market activity of the past couple of years is being replaced by dispersion and fastidiousness. Intentional, disciplined investors who focus on fundamentals and facts will be rewarded in this environment.