Posted by on May 11, 2015 in Blog, Columns, Featured |

Image Credit: Christophe Vorlet

By Jason Zweig | 12:43 pm ET May 8, 2015

This past week, some of the hottest portfolios in the country—funds with names like Canyonville, Westminster and Passaic Valley—shut down after racking up spectacular returns.

These aren’t hedge funds. They are play-money funds run by high-school students for a stock-picking contest.

Before you conclude that this game has fostered a bunch of budding Warren Buffetts, you need to understand what many of these young portfolio managers were trying to do: to beat the market over a 14-week period by taking as much risk as possible.

This Thursday was the final day of trading in the annual Capitol Hill Challenge, part of the Stock Market Game competition sponsored by the SIFMA Foundation, the nonprofit educational affiliate of the Securities Industry and Financial Markets Association, the leading trade group for the brokerage industry.

This year, 4,400 teams of students from high schools and junior high schools around the U.S. competed to earn the highest return on an initial $100,000 of hypothetical money. The top 10 teams get an all-expenses-paid trip to Washington, usually including a private meeting with their members of Congress.

The SIFMA Foundation says the game is intended to teach youngsters “the importance of long-term saving and investing.”

Under the contest rules, a team can’t put more than 20% in a single stock (33% in some states); nor can it buy a stock trading below $3 a share or with a total market value of less than $25 million. Nor can a team take out a margin loan greater than 50% of the portfolio value.

So, naturally, the students who want to win the game hold three to five stocks at a time—the smaller and the riskier the better—and borrow to buy them.

Ryan McCabe and Vincent Botti, 18-year-old seniors at Passaic Valley High School in Little Falls, N.J., borrowed about $45,000 on top of their $100,000 and bought a handful of tiny biotechnology stocks, including Malvern, Pa.-based Recro Pharma, which has a total stock-market value of $73 million, ran a net loss of $17 million last year and states in its annual report, “We have never generated any revenue and may never be profitable.”

“We knew biotech would be either a big hit or a big miss,” Mr. McCabe says.

“You’ve got to go full steam ahead when you’re trying to get to the top” of the standings, Mr. Botti says. “If you don’t have enough guts to put it out there, you’re never going to succeed.”

In the preliminary rankings as of May 6, their team was in fifth place nationally with a 61.6% gain in just under 14 weeks. Over the same period the S&P 500 was up less than 4.9%. The final results will be announced later this month.

“Nobody’s going to win the Stock Market Game picking big safe stocks everybody’s heard of,” says Jay Watts, a teacher at the Westminster Schools in Atlanta.

Elizabeth Izlar, an 18-year-old senior at Westminster, says her team borrowed 50% on margin and put all their money in three biotech stocks: CorMedix, Atara Biotherapeutics and Theravance. As of May 6, the Westminster team was in third place nationwide, up 66.8%.

“This game allows you to buy risky stocks and survive,” Ms. Izlar says. “In real life you probably should not invest this way.”

Roger Shaffer, an administrator and teacher at Canyonville Christian Academy in Canyonville, Ore., advises his school’s Stock Market Game. “I really don’t want to teach things to kids that could have disastrous consequences,” he says. “Rabid speculation and high-risk techniques can reach up and bite them down the road.”

But, he adds, “I also want them to have fun with it and go to Washington, D.C.”

So, Mr. Shaffer says, he begins by hammering home the sound principles of long-term investing, including diversification and patience. But he then tells his students, “The way to win this competition is to break every rule of sound investing that I just taught you.”

His teams are particularly fond of triple-leveraged exchange-traded funds, which they buy using 50% margin. In plain English: They buy ETFs that gain 3% for every 1% daily rise in a market index (and lose 3% each day the market falls 1%). Throw in the borrowings, and these kids gain 4.5% when a market gains 1%—and lose 4.5% when it falls 1%.

“Wild-eyed, gold-rush, Klondike speculation, that’s what wins the Stock Market Game,” says Mr. Shaffer, who has three teams in the preliminary top 10. His hottest team, in first place as of May 6, is up 84.3%.

Melanie Mortimer, president of the SIFMA Foundation, says the game teaches students “personal financial literacy,” gets them “engaged with what goes on in the global economy” and equips them “to understand the implications of their decisions and potential consequences.”

SIFMA says more than 15 million students have played the game—more than 600,000 of them this year.

If your own children are studying the stock market in school, you had better ask them what they have been learning. They might need to be deprogrammed.

Source: The Wall Street Journal