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The Peril of Being a Copycat

June 26, 2014 | About:
Grahamites

Grahamites

150 followers

An acquaintance of mine recently expressed his regret in selling out his Idenix Pharmaceuticals Inc position before it got bought out by Merck. He was frustrated by having missed out on big profits. I asked him whether he understands complicated bio-pharm. He said no, bio-pharm is out his circle of competency. Then I asked him how much research he had done, he said the minimum. In the end, I asked him why he bought the stock without doing much research. His answer was “because Klarman bought it.”

This is not an isolated instance in the investment world. I’ve seen a few other folks blindly following gurus, be it Seth Klarman (Trades, Portfolio) or David Einhorn (Trades, Portfolio), without proper due diligent on their own.

Charlie Munger (Trades, Portfolio) has once said – the best way to get what you want is to deserve what you want. This is true in life and especially true in investing.

I don’t have a problem with being a copycat in investing. In fact, I’d argue that a great many of the superinvestors get a good amount of ideas from their circle of friends. Therefore, there is nothing wrong being a copycat. However, there is a huge difference between being a great copycat and being an undeserving copycat. This difference lies not only in the amount of due diligence that is required, but also in the mentality behind one’s investment decision making process. Do you like the process of solving a puzzle or do you just like the feel of making money, or do you enjoy both?

In order to be a great copycat, you have to control your greed and say no to the “action man” inside your brain. You also have to remember that borrowed convictions are often the most dangerous ones. Great copycats have a system that enables them to filter out the ideas that are out of their circle of competency and at the same, keep their greed in control by implementing a checklist approach. Mohnish Pabrai (Trades, Portfolio) is a prime example. Although he calls himself a shameless copycat, his success is much deserved in my opinion because the amount of time and effort he spend in filtering out ideas and doing research is probably pretty damn impressive. Just look at his portfolio. How many of the copycats out there have a portfolio as concentrated as Mohnish? How many copycats have the discipline to act only on a few big compelling ideas? And how many copycats have the conviction Mohnish has about his positions?

Most of the copycats are not like Mohnish. They forget that finding the ideas is only the first step. What is more important is the filtering process the subsequent research process. The peril of being a copycat comes from the mental attitude of taking shortcuts in investing. You may have made money out of luck by copying other great investor’s ideas.That makes you feel good but that doesn’t make you a good investor.You may be tempted to jumping out of your circle of competency due to greed. You may be tempted to blindly follow a superinvestor because you don’t have the time to research the idea. Whatever the reason is, you should not copy an idea without proper research on your own. If you don’t have enough time, remember Buffett’s advice – you don’t have to swing at every pitch.

Of course the most dangerous part about being a sloth copycat is the real possibility of losing money. If you have followed Bill Ackam’s JC Penney or Prem Watsa (Trades, Portfolio)’s Blackberry investments, chances are you are still underwater. I’m not saying they are necessarily bad investments. It just seems to me that it is very easy to form an opinion on these two names without much research and with big names behind them, it is easy to act on them. In fact, I’d argue that both JC Penney and Blackberry should fall into the too hard category for most investors. A too hard-situation combined with not enough proper due diligence can be one of the most dangerous situations in investing.

I may have sounded a little harsh in the above discussion but let’s not forget what Munger has wisely warned us: It's not crazy enough so that the world is looking for a lot of undeserving people to reward. My intention is not to inform the readers what is the proper attitudes toward borrowing other’s ideas, but to remind us that the best way to achieve superior investment result is by deserving it.


Rating: 4.7/5 (18 votes)

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Comments

popeyes101
Popeyes101 - 5 months ago

Not sure if I agree, quoting Mohnish himself

"I read a study a few years back where some university professor had documented returns one would have made owning what Buffett did - buying and selling right after his trades were public knowledge. One would have trounced the S&P 500 just doing that."

Given this, copying the greats seems to make sense. I don't buy the "deserving" argument. Bill did not deserve JC Penny fate, if effort was the measure.

suresharora
Suresharora - 5 months ago

Valid points in the opinion piece. One can decide to simply copy ideas that may be within their area of competency but that has its own peril - an average investor's compentency cannot match the know how of the investor you are following. One can use few guidelines to improve their probability of success in aping:

- Really get to know the style of the Investor you are aping and have a clear idea of how they select their investments. Klarman is a long term investor, so be prepared to stick with the position and be prepared to add to your initial position. Also, be prepared for the losses if he exits the position - your losses may be higher than him since you will have the lag time to deal with

- If you are aping a short to medium term investor, set your exit points when you initiate a position - then stick to it - GREED IS YOUR ENEMY

- Stay away from aping investors who use complex strategies e.g. Ackman. You will have a hard time figuring out the complete picture - hedging, etc. If you still insist to ape them - use a tighter band for the exit points - control your greed and fear of loss.

goforit
Goforit premium member - 5 months ago
I purchased 5,000 shares of IDIX at an average price of $5 in March and sold at $24 in early June. Thank you Seth Klarman (Trades, Portfolio)!

ecotycoon
Ecotycoon premium member - 5 months ago
Once again a outstanding article Grahamites. Here's what i have in my check list to avoid this mistake:

-"I have done the right research and analysis to have the conviction of having a better perception of the intrinsic value of my investment thesis than the other participants in the market."

-"During the investment process, I had remove the sense of self to avoid my ego getting involved and distorting even more my perception of reality. "



Source of my check-list ideas:

Best George Soros (Trades, Portfolio) Quote in know about at 8 minutes:

https://www.youtube.com/watch?v=sHz2SX-A4sw



Cheah Cheng Hye, on removing the sense of self at 29min40sec and when to sell at 32 min :

http://www7.gsb.columbia.edu/video/v/node/989







vgm
Vgm - 5 months ago

Thanks Grahamites! This is a very important and underrated topic. In my experience, properly done, copycating can be a very effective source of successful investments.

I agree with much of what Suresharora wrote above. It's critical to choose your gurus carefully and understand their style(s). And I think it's advantageous to pick gurus who run highly concentrated portfolios. We need a bit of humility too. I'm happy to admit that my gurus are way better than I can ever hope to be. On the other hand, we should realize they are not infallible. Klarman has a mixed record in biotech, for example.

Pabrai was given 3 approaches to investing by no less than Munger. One of them was to follow the filings of successful investors:

http://www.fool.com/investing/general/2013/01/15/charlie-mungers-three-rules-on-how-to-become-a-suc.aspx

http://hcvinvesting.blogspot.co.uk/2013/01/mohnish-pabrai-motley-fool-interview.html

Finally, I'd add that when more than one of my gurus makes the same pick then it becomes even more compelling to investigate. Lou Simpson (Trades, Portfolio) and Glenn Greenberg (Trades, Portfolio) are two of the few I follow carefully where there can be overlap. (The number of 'gurus' on GF is a contradiction IMHO. Too many of them are average - at best. They could benefit from careful copycating!)

Grahamites
Grahamites premium member - 5 months ago

Popeyes101- Thanks for your comments. You may be right in disagreeing with me on the deserving part.I've known people who have done it successfully without too much research but they are the minority. By and large, I think the best way to achieve superior investment results is to deserve it by working harder and smarter. This is just my personal experience though.

Grahamites
Grahamites premium member - 5 months ago

Suresharora - Thanks for your comments and totally agree with the points you raised. They sure will help you increase the odds of success. I would also add that you should be selective in terms of which ideas you want to copy to avoid into getting into a position where you have too many positions to track.

Grahamites
Grahamites premium member - 5 months ago

Goforit - Thanks for your comment and congratulations on your successful trade:)

Grahamites
Grahamites premium member - 5 months ago

Ecotycoon- Thanks for the nice words and thanks for spreading wisdom. I do think a checklist is extremely important and it is likely no matter how important it is, very few people will use it just because of the way human brain works. Watch out for your ego is also incredibly important and boy, does that stand in the way of most people's investment results.

Grahamites
Grahamites premium member - 5 months ago
Vgm - Thanks for your comments and very insightful observations. I appreciate your sharing those Pabrai posts with us. I think every serious investor should study Mohnish. What he has achieved is truly remarkable.

I think your final point is very smart. I've used that approach a few times in my personal experience. Some gurus have a higher likelihood of overlapping because their style is simliar, such as Tom Gayner (Trades, Portfolio) and Chuck Akre (Trades, Portfolio). It's often worthwihile to study those overlapping positions in greater details.

Thanks again for a thought-provoking response.

gerrydjr
Gerrydjr - 5 months ago
Just keep buying great businesses at reasonable prices.......that the gurus also purchase. Over the long run you will win. My time horizon is forever and I am sure coca cola, Johnson and Johnson, and Exxon Mobil will out-live me, my kids, and theirs.
davidchulak
Davidchulak premium member - 5 months ago

Thanks for the article. I basically agree. That's why many are here after all. You emphasized due dilligence which cannot be repeated often enough. A concern is when a guru goes long on a position he is actually short to hedge his position. Chanos comes to mind. Just because you see a "long" consider all. Once again, thanks for the good article.

snowballbuilder
Snowballbuilder - 5 months ago

@grahamites as usual I appreciate your articles

but this time I'm not convinced of your thesis

Im not a copycat but , to be a successful copycat , i think you have simply to choose one great investor to follow

(munger , buffett , berkowitz , simpson , icahn ecc ) and simply copy his trade

"buying and selling right after his trades were public knowledge. "

you have to choose one great investor ,fully trust him and consistently follow his step.

in the long run if the investor you have choose to copy will do well ... you will also do well .... its that simple.

there is nothing to understand ... I think the ordinary guy will do better if simply copy from the best

Pabrai is not a copycat ... is a great and skilled investor that use the other guru's trade as source of inspiration .

But the ordinary guy should remember that… in investment as in all other activity in life … only 1 on 10 is in the better ten percent…. and only few investor consistently outperformance the S&P 500

So if you want to copy... copy from the best… in the long run you will probably do well.

Just some thoughts

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