Speaker Key:
GS Gregory Sweet
JG Jason Gibbs
MF Mark Fairbarn
VO Voiceover
00:00:00
GS Prediction markets are officially coming to Canada. And if you're looking into it, you've probably noticed there's a lot of information out there and just as much misinformation. Welcome back to Let's Talk Investing. I'm your host, Craig Sweet. Today, we're joined by two of our portfolio managers, Jason Gibbs and Mark Fairburn, to help cut through some of the noise. By the end of this conversation, you should have a much clearer sense of whether a prediction market actually makes sense for you. So let's start with the basics. What exactly is a prediction market?
00:00:33
MF A prediction market is where people can trade what are called event contracts that are linked to binary outcomes, with the contract having a binary payout. The payout is either 0 if the event did not happen or 1 if the event did happen. The price of that contract is effectively the implied probability of that event happening. If something has a 70% probability of happening, the price should be about 70 cents. In a rational market anyways. Of course, the probability of something happening or not happening is never precisely known. A coin toss is 50/50 unless your coin is broken. But for most real world events, there are no true probabilities for the outcome known in advance. But prediction markets allow us to see what probabilities are applied by the collective wisdom of the crowd through the price discovery process on the contract. Where the price sits reflects the current collective wisdom of the crowd or market, hence calling it an implied probability. And as this collective opinion changes, say in response to new information, the price will change. Of course, this assumes you have a crowd. Thinly traded contracts are less likely to be robust in their applied probabilities because there's fewer participants. Where the price sits reflects the current collective wisdom of the crowd or market, hence calling it an implied probability. And as this collective opinion changes, say in response to new information, the price will change. Of course, this assumes you have a crowd. Thinly traded contracts are less likely to be robust in their applied probabilities because there's fewer participants. Now, in the U.S., you could trade these on pretty much anything. But in Canada, the regulatory framework is such that these are financial derivative contracts and can only be based on outcomes linked to economic indicators, financial markets, or the weather. So think, will the TSX hit 40,000 by year-end? Will the Bank of Canada raise interest rates? Or even something as trivial as, will it rain in the next 38 days? Yes, you heard that last one correct.
00:02:06
GS The weather, wow. So if it's this simple, yes, no, will it happen, won't it? Why is this getting so much traction right now?
00:02:14
JG Gambling has always been around. I mean, humans have always gambled. They've always found an interest in gambling. So a lot of this is not new. What is new, though, one, it's legal, right, including sport and other areas. So that's a huge change. and also technology obviously right with our phones it's so easy to do this. So you marry the fact that it's legal with easy technology with companies that want to make money and fees And you have a big problem on your hands in my estimation. You know, if we go back to why do people find an interest in this? For me, it's always like it's a quick dopamine hit and everyone's always searching for dopamine. It's the lottery ticket effect, right? And I would suggest our brains are always looking to to gain control over situations. But one of the factors of life is that the vast majority of life is beyond our control. And a lot of people naturally struggle with that. So when you get into prediction markets and gambling about the future, it's somewhat of an attempt to gain control over that and also profit from that. But of course, that's an illusion.
00:03:33
MF Curiosity about something isn't a reason to put money into it. Novelty and worthiness aren't the same thing.
00:03:41
GS And that's really the thing. A single bet can feel harmless. But once that starts turning into a habit, into something perceived as a strategy, that's where it gets risky. Talk to me about what actually happens to someone's decision making once they started doing this regularly.
00:03:56
JG Like anything when you're thinking of dopamine and habits, if you get really into it, you're always wanting more and you're wanting those wins. The issue with gambling is that those who profit from it, being the casinos or the institutions that allow you to gamble, they want you to be on that phone as long as possible, right? And if you're at a casino, they want you to be in that casino as long as possible. So they'll make it as easy as possible for you to do that. And anyone that's been to casinos or Las Vegas is very aware of that. There's a very simple reason for that. The stats are very obvious and it's very plain and there's been a lot of research on this. The longer that you gamble, so be that days, months or years, the probability of you losing money almost goes to 100%. I mean, it's just that's the way it is. I would suggest the other issue is when you get to the markets, remember the markets always run on emotions and cycles. And this is a very, very old bull market, right? So I remember March 2009 when everyone assumed all of the banks around the world would go under and no one wanted to touch stocks with a 10-foot pole. Well, what we have now is you kind of flash forward. People get more comfortable as the years go on with stocks. They start putting more money in. And now you're in an old bull market where people just think it's easy, right? And that kind of leads to just more excessive behavior. And we're starting to see that. So whether it's higher margin accounts or triple leverage DTFs, you're definitely starting to see that.
00:05:44
GS So that's this concept that bull markets die in euphoria, right? You know, I'm not calling the top here, let's be clear. But we are at a point in the cycle where that euphoria starts creeping in, that belief that everything will generate positive returns.
00:06:01
MF Yes. Behavioral risk shows up as short-term focus replacing a long-term plan. More emotional decision-making, constant engagement, pulling people off track. It's really one of those things where people can be in such a hurry to get rich fast, they end up chasing big, fast payoffs, opposed to the proven approach of compounding return over the long-term in tried and true investments. The dangerous part is the catch-up mindset. I'll win it back on the next bet. Or that worked once, so it's a proven strategy. That's not a strategy. That's just chasing and luck.
00:06:35
GS Okay, I think that's why we're taking this so seriously. We have this duty to ensure that our clients are making smart decisions with their investments. So let's talk about the numbers for a second, because I think this is where it gets real for people. Prediction markets are largely zero-sum. For every winner, there's a loser. Investing isn't like that. The total value of the market can actually grow over time. Think of it this way. In a prediction market, the pie doesn't grow. Participants are simply competing for a share of that same pie. In investing, the pie can actually expand over time as businesses grow, earn profits, innovate, and create value. So here's some interesting stats. Roughly 71% of users lose money over time. While the top 1% capture more than 80% of all profits. Gains concentrated among a small group of highly active, sophisticated traders. And it's not just about the stats. We haven't talked about fees. Platform fees. A cut gets taken from every trade. And with the fast, frequent trading, that can really add up. So the fees itself become a guaranteed drag on the whole pool for traders, not just for the losers.
00:07:46
MF This isn't unique to prediction markets. One well-known academic study of day traders found that fewer than 1% of those were able to consistently turn a profit once fees were factored in. Same story, different market.
00:08:01
GS Now here's something a lot of people probably don't realize. This isn't actually the first time these have existed in Canada. In 2017, the Canadian Securities Regulator banned this type of contract. Now, a limited subset is being permitted back under stricter oversight and conditions, but it's really worth being upfront. The concerns behind the original ban, like fraud, investor harm, the manipulation risk, haven't fully disappeared just because the framework has changed. So take that seriously, not just as old news. Okay, so is there a legitimate use for these? or is it just noise?
00:08:38
MF Yes, but maybe not in the way most people think. So us as portfolio managers do actually look at these around major events to determine the likelihood of different scenarios, elections for example, The wisdom of the crowds is real, and when people have real capital on the line, they put more thought into their positions than, say, participating in a poll. But as an investment strategy, outside of entertainment, the winner is the hosting the platform and taking a cut. The same way owning a casino is a great business, but gambling in one usually isn't.
00:09:23
GS Okay, so another data point, the odds reflected in these markets can be more or less an input into the portfolio manager's long-term logical decision-making process. Key distinction. It's an input, not a substitute for fundamentals or portfolio construction. Our focus is on helping clients achieve their long-term financial goals, which means evaluating opportunities based on the value they can create for investors over time, not simply the activity they generate.
00:09:58
JG One thing for people to remember, real investing is about the long term, right? You're talking years, you're talking decades, you're talking protecting your capital, patiently growing your capital, not worrying about what's going to happen next week or whatever. You're thinking about investing in some of the great companies in the world, both their equity, both their debt, companies... that have services that you and I use every day and we're likely to use over the next several years. But when you're investing, you're thinking about probabilities, right? So... What are the probabilities that people will be using these products and services over many, many years? Are the probabilities high? Are the odds high? And how high are those odds? And then you're thinking about what you're buying this company at in the stock market and how much risk is implied in this stock price. What is this stock price implying? So you are doing math, you are looking at probabilities. And the great investors, frankly, are very patient. They don't do a lot every day or every week. They wait, wait, wait like a great baseball hitter until the odds are massively in their favor. That's what investing is all about. The long term probabilities, great companies, cash flows, good balance sheets. When you think about prediction markets, that's got nothing to do with investing. That's all trying to figure out or trying to predict what's going to happen today or tomorrow with respect to an event. Like maybe you might get some enjoyment out of it, but it doesn't mean anything and no one's got any sort of edge at all. So it's the two very, very different things. It's always there's investing and there's speculation.
00:12:06
GS Okay, let's get specific for a second, because I think this is at the heart of it. What actually makes something an investment versus a bet?
00:12:13
MF I think the key difference between an investment and a bet is having some tangible return driver. If you own a stock, you own a real stake in a real company, a claim on its future earnings, its growth, and often dividends along the way. If you own a bond, that's a contractual commitment. You get your capital back plus interest over time.. Both have a structured, ongoing mechanism for generating a return. It's not flashy, but it works. And everyone who participates can benefit from it. It is not a zero-sum game. Prediction market contracts have none of that. It's a fixed outcome wager. Someone wins, someone loses, and that's the end of it. There's no ownership, there's no growth, and there's no compounding.
00:12:57
GS So if it's not about being right on one call, what should investors actually be focused on?
00:13:03
MF If you have one correct prediction, that gets you an isolated gain, and then you have to do it again and again to keep winning. Even if you made a bet with 90% odds, there's still a 10% odds you lose all your money. However, a portfolio compounds on an ongoing basis. The only thing you actually need to be right about is your own circumstances, your time horizon, your goals, and that's something you work through with an advisor, not something you have to predict. Sticking with a long-term plan won't always feel exciting or headline worthy, and that's kind of the point. Also, keep in mind, if prediction markets are fairly priced and the wisdom of the crowd is sage, if you repeatedly make a bet with, say, a 75% probability, you'll pay 75 cents on average for each of those bets. You do it over and over, and your expected value will be the exact amount of money you put into that. You will effectively break even as you'll make on some and lose everything on everything else. The net result is a total return of zero, but take away the transaction costs that you took along the way and you've lost money. This is an important point. You only make money if you systematically figure out the odds or mispriced. There is no baseline odd, unlike there is in financial markets. Equity markets typically go up 70 to 80% of the time. The longer your time horizon, the higher the odds that you succeed. That is the key difference in my mind.
00:14:24
GS Okay, that's good advice. So what should someone do instead if they're feeling this pull towards prediction markets? I'll tell you this, you do not need prediction markets to succeed. You need a long-term investment plan, a diversified and balanced portfolio. You need discipline and advice. And it's worth coming back to something that we said earlier in the episode. The decisions that actually matter are seeking advice, getting invested, and staying invested. The rest is truly just noise. Honestly, the biggest single thing a client can do for their financial well-being is to take action on the recommendations already sitting in their written financial plan. The advisor, the client, professional money manager working together. That's actually what helps people achieve those long-term goals.
00:15:09
JG When I think about the topic of the day today being prediction markets, the only thing I can offer, I would think of it as if you are going to do things like this, if you do get into betting or a little bit of gambling or this or that, like budgeted as almost an entertainment expense, you know, like when you go to a concert, you're never going to see that money again, but hopefully you have a good time. You keep that expense to a very, very low number when you think of your annual budget. But it's not like buying a stake in a company or a stock or a fund where you're looking for that to compound over many years. And obviously you're looking for that asset to grow. Just make sure when you're looking at prediction markets, it's got nothing to do with investing for the long term. It has everything to do with very simple predictions.
00:16:04
GS And to be clear, we're not telling you what to do here. We're pointing out the actual risks to your long-term goals. If it's appropriately budgeted, unspoken for money, and it's fun for you, it's fine. Just keep it separate from how you're actually investing. Before we wrap up, a few questions worth asking yourself if you're considering this. Am I chasing a short-term opportunity? Would I approach this the same way without all the hype? Is this helping or hurting my long-term financial goals? And if you're not sure, that's exactly what your advisor is there for. You don't need to be right about events. You need to be invested through them. Jason, Mark, thanks for joining me today on what was an important conversation. And to those listening, thanks for investing your time in today's conversation. Be well and keep investing.
00:16:51
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