Four reasons why private investors have an edge over professional fund managers

8th Oct '18 by Oliver Cooper

34 comments 8750 reads

Kevfle recently posted an intriguing article called “Can we beat the professionals?’ In this he touched on some interesting questions around the investment industry, which provoked a flurry of responses from our fantastic community here at Stockopedia.

Kevfle seemed to have several questions on his mind, including:

Can we actually ever outperform the pros?
Am I wasting my time?
Is it easier to choose and evaluate a group of funds instead?
Can I achieve similar results leaving it to the pros?

In the first of this two part series, I will seek to address the first two questions, investigating where there might be scope for the individual investor to outperform and whether it’s worth the effort.

Can we ever outperform the pros?

In order to answer this, we need to define where our edge is.

Firstly, let’s take a look what we are up against. Our competitor investment management company has an army of analysts, each highly qualified with an MBA, PhD and several investing qualifications. They are able to assign individuals not to look at a whole market, but investigate businesses within an industry or in some cases just a handful of companies that the analyst will eventually get to know better than their CEOs. All of these ideas are pitched to the fund manager who then decides, with help from their 6-figure-per-year risk system, how to construct the portfolio.

The scale advantages may seem overwhelming, but there are several disadvantages that the institutional investor must contend with. It is in these disadvantages that the private investor can seek their edge.

The first is liquidity.

Investor Edge 1 - Liquidity

“It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.” - Warren Buffett

“If I were working with a very small sum – you all should hope this doesn’t happen – I’d be doing almost entirely different things than I do. Your universe expands – there are thousands of times as many options if you’re investing $10,000 rather than $100 billion, other than buying entire businesses. You can earn very high returns with very small amounts of money.” - Warren Buffett

The average equity fund manager has around £650m in assets. This means that if they want to allocate 4% of their fund in a…

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Smudger

11th Oct '18

I would like to see the Buffet guru screen that generates 50% annual return!

csholmes

Interesting insight into the life of fund managers.

svend kristensen

Me too I concur ?

I agree with David please show us the the Buffet guru screen that generates 50% annual return

FREng

Is there a fund benchmark website that makes it easy for PIs to benchmark our performance against active fund managers?

hawkipa

Great article and thought provoking.
One thing I didn't consider until recently was the cost benefit of self managing. Say you paid a wealth manager a nominal 1-1.5% just to manage and administer your fund before other costs then that is a real amount you are saving and able to invest each year and could be viewed as a form of payment for your service to yourself in the money saved. That then helps with the compounding.

Frankyboy

Some useful points made. I'm mainly a chartist and I would suggest that the best results might be obtained by combining fundamentals with chart timing. Why sit through sell-offs, such as are happening now, when you can 'sell before the sell-off' using charts. Stick the percentage sell-off in your pocket and start again when the market starts to recover.
The ability to jump in and out of the market is, I think, the major advantage which individual investors have; being able to be fleet-of-foot...especially now that charges are more reasonable.
I do not think that the ability to have a longer time frame is necessarily an advantage. Please look at a long term chart of the FTSE100. Was it sensible to sit through the '2000' or '2008' dives? It's all about timing. Olive Cooper suggests that it is an advantage to be able to extend the time horizon to seven years. This makes no sense to me and it pays (literally) to think about timing. Otherwise it's leaving it to Lady Luck.
Say you were unlucky enough to have bought innocently into the market in late 1999. With Oliver's advice you would have ridden the market down to the 2003 bottom and then nearly up to the 2008 crash. You'd HAVE to have done that to NEARLY have got your money back! :)
This 5yr time window which the old brokers advised was based on a long stable period in the market and also it allows(ed) them to cover up their mistakes of advice given to their customers. You can tell how much brokers can look into the future by following broker's consensuses....they are rarely accurate.
There's a lot of monkey business in the Stock Markets and you can see it if you look at enough charts.
I would suggest paying some attention to them.

tagware

Very good and practical reasoning behind this article. As it has worked very well in our case. I can't really do anything but recommend it to follow. 450% increase over 5 year period is nothing to be sniffed at. :o) True I do work and play in the Tech industry. Which has helped. :o)

I think you meant to say 450% in 1yr? I wouldn't get out of bed for 450% in 5yrs!
:)

MichaelFBS

"It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.” was a statement Warren Buffett made to BusinessWeek in 1999 and he was perhaps being hyperbolic but in the partnership days running small amounts of money he averaged 29% pa. Not 50% but still I would settle for 29%. That's 10 bagging in 10 years.

jonesj

There will not be a screen that shows 50% consistent return.

That is because exceptional returns will require exceptional judgement. Warren Bugget & George Soros will do better than any screen.

As Charlie Munger says, why would you expect it to be easy to get rich ?

Frankyboy I assume that this was tongue in cheek? 450% pa turns £100 into £2,317,809,042,866 i.e the size of the UK economy.

450% over 5 years is not sustainable over the long term just put the numbers in to a spreadsheet.

I have been investing properly for just under 4 years now and was, until this week, getting a little bit full of myself with my own abilities. The last four days has given me a reality check and that is a good thing. What I had achieved was not sustainable as they would have made me one of the richest men in the UK with a couple of decades and I was measuring myself over too short a time period.

I have learnt this week that severe market falls are emotionally very hard and draining. When your own portfolio drops 10% in a week it is much harder to take than when say you have all your money with Terry Smith, Fundsmith drops 6% in the same week. Very much a long the lines of a problem shared is a problem halved.

I very much enjoy the intellectual challenge of being a PI but whether I can stomach the emotional roller coaster is yet to be established but I do want rewarding for these so my own performance has go to out perform my own choice of index, that being say a combination of BRK, Fundsmith, Ashworth - Lord, Gervais Williams over at Miton and/or a mechanical system using Stockopedia and being put through its paces by Ed Croft with his Naps selection. Yet to work that out yet but will do at some point. Otherwise it is simply wasted energy, emotion and money.

Thanks for a very interesting article.

Also a £100k becomes £13bill in three decades which is a little unlikely!

I would suggest that targets be much more modest. Pick your index or fund or funds and hope to out perform by a couple of percent. Out perform Terry Smith say by 2% and you will 25% ahead of him in 15 years.

Maybe I am being to modest in my targets but would welcome others thoughts.

I am not sure whether there is but when I get the time I intend to contruct one myself. I think I can do it using Yahoo Finance by "buying" units in my chosen funds and seeing how that performs compared to my real life portfolio.

I think it should be relatively easy.

Unfortunately I cannot do it with Stockopedia as the funds I would benchmark against are not available.

Hope that helps.

Four reasons why private investors have an edge over professional fund managers

Can we ever outperform the pros?

Investor Edge 1 - Liquidity

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Oliver Cooper

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