Most investors do not realise, but as a private investor managing his own money, he has got an immense advantage over a fund manager due to factors he may not even be aware of.
Sure it will take up some of your free time but it will probably be one of the most awarding activities you can invest your time in.
We have all worked hard for the money we have saved and it would only be prudent to invest in in the best way possible.
With public pension systems crumbling around the world because of ageing populations, making the most of your savings had gotten much more important.
Below are the advantage I have come up with. If you have any to add please send me a short note.
1. You can wait
As a private investor you can wait for attractive investment opportunities to present themselves. If you cannot find anything attractive you can stay in cash.
Fund managers do not have this luxury. They have to invest in whatever their investment area is irrespective of valuation.
Holding cash in the fund management world is known as career risk as the fund manager runs the risk of falling behind his peers or his benchmark. The larger the cash position the higher the career risk.
The best example of career risk I have read is value fund managers losing their jobs because they refused to buy internet shares during the internet bubble.
2. You can invest anywhere and everywhere
As a private investor you can invest in any type of asset in any country that offers an attractive risk return trade-off, be it corporate bonds, equities, options, real estate etc.
Fund managers have to stay within the fund's investment area. Additionally complying with regulations, even further limits their investment choices.
You can argue that you can change to a fund in another investment area but that is also actively managing your money.
3. You can invest in any size
This is similar to the investing anywhere and everywhere as you have the freedom of investing in small or large companies whatever is most attractively priced.
I was recently astounded when I heard of a value fund manager that had to invest in companies that have a high weighting in a particular share index because he had institutional investors (read large investors) that would withdraw their funds should his performance deviate too much from the market.
This is ludicrous, why invest with a value manager if you really want market index performance? You want a value manager to do what he does best, search for undervalued companies.
4. You have no benchmark
As a private investor I only have one goal in mind, to grow my investment portfolio each year irrespective of what the market does.
I do not consider it a good year if I have lost 25% while the market has lost 40%.
I am sure your goal is the same.
Fund managers only have one goal, beating his benchmark irrespective of absolute return. I cannot remember how many times I have heard a fund manager say that he has to remain fully invested in his investment area as that is what his investors expect of him.
Just think of what happened to investors in technology funds as the internet bubble deflated.
5. You can focus and ignore
Studying, understanding and applying what has worked in investing is all you need to do to be wildly successful as a private investor.
You can only focus on a few things and ignore the market noise, you only have to spend relatively little time to be successful.
Fund managers have to have an opinion on a lot of different investment areas because they have to appear competent in company and client meetings. It is tough for them to have to say I do not know.
I do not watch financial television, its complete rubbish and a waste of time. Mainly yo-yo news i.e. what went up and down.
I have my investment criteria, I look for companies that falls within it and I study only that. The rest does not interest me and that saves a lot of time.
6. No conflict of interest
This is a big one. You only have your best interests at heart. In other words all your decisions are in your best interest.
Fund managers have to think of keeping their jobs, increasing their assets under management and keeping clients happy.
All this means is that their investment performance is not the most important thing on their minds.
Also fund managers in companies what also offer investment banking services may be pressurised to buy securities of investment banking clients irrespective of investment attractiveness.
7. You can have a long view
According to a study by the New York Stock Exchange the average holding period of shares held by investors have declined from five to six years in the 1950's to 11 months.
That means that the average investor has an investment horizon shorter than one financial year.
It is unlikely that a company with problems, as undervalued investment inevitably have, can sort them out in such a short period of time.
As a private investor you can follow the company over many years and realise the gains when the company gets revalued by the market.
This may be the largest competitive advantage you have. The ability to look at a company solely on valuation and keep it as long as it is undervalued.
8. No peer pressure
Accept if you discuss your investment with friends or family you will have no peer pressure to buy or sell any investments.
I have gotten to the point that I am reluctant to discuss my investments because the response I get is either, “never heard of it” or “what, you must be mad, don't you read the newspaper?”
Fund managers have a different problem. The funds they manage get compared to benchmark indices and other funds, including the individual fund holdings. Should you stand out in any way invites questions. Should the performance be worse than the peer group or benchmark career risk increases.
If you manage your own money you have none of these problems.
9. You decide
You make the final decision after you have done the analysis. You may be wrong but at least you make the calls either way.
A lot of funds are managed where committees decide what is bought and sold. Apart from the problems of group-think investment committees are staffed with people throughout the organisation with different investment approaches, not all of which has shown good historical results.
Furthermore it may be difficult to tell your boss that his investment idea stinks if you have your bonus evaluation later that day.
This leads to suboptimal and sometimes completely dysfunctional decision making.
10. You can concentrate
If you find a really compelling idea you can choose to invest as large a part of your capital as you feel comfortable with.
With 80% of non-market risk diversified away with as few as 15 positions you can determine what your optimal number of investments are.
Mine is 30 as I feel comfortable with the weighting of each position in my portfolio and I can easily keep track of the investments.
When I see funds with 100 or more investments my first thoughts are that they must not have much conviction in any of their ideas.
Also with so many positions you may as well buy the market itself through an inexpensive exchange traded fund.
11. You control the costs
Controlling costs and fees, or the friction of investing, is a very important part of part of realising superior long term results.
Using a discount broker I can buy and sell most shares for around 1% brokerage. If I hold a position for three years that equates to 0.33% per year plus a 0.25% custody fee.
That is a lot lower than funds that charge 1% to 1.5% per year on top of a 5% initial fee and other expenses.
Calculated over a period of 20 to 30 years keeping costs low makes a huge difference.
12. Down years are more bearable
This goes along with the point on making your own decisions.
Should you have a bad year at least you know you made the decisions, can learn from your mistakes and make adjustments to your investment strategy.
13. You can be fully invested
Should you find a large number of attractive investments you can be fully invested and remain so even if the markets declined and you are still convinced of the investment case of each investment.
With a fund manager this is unfortunately not the case. When markets fall they are bound to get redemptions. In order meet the redemptions they must either have cash available or sell investments.
But when markets are falling liquidity drops as well. That means that because investments have to be sold liquid investments are sold first. This selling pressure puts pressure on share prices leading the markets to fall further thus triggering more redemptions. You get the picture.
Some fund managers plan for such eventualities be keeping a certain amount of liquid investments or by keeping at least a small amount of cash on hand.
This as mentioned in one of the points above leads to suboptimal investments not necessarily the managers best ideas.
Luckily as a private investor you do not have this problem.
I always keep a cash reserve of one years living expenses aside to ensure that I do not have any pressure to sell investments should the market decline unexpectedly.
Also a large cash reserve gives me the peace of mind and opportunity to focus on investing for the long term.
There are of course a few funds where the drawbacks mentioned below do not apply but they are in the minority. The large bulk of fund management companies are focused on growing the amount of money they manage, where maximising the returns to investors come a distant last.
Tim du Toit
Tim du Toit is the editor and owner of Eurosharelab. He has more than 20 year of institutional and personal investing experience. Tim is based in Hamburg, Germany. More of his articles can be found at http://www.eurosharelab.com
Sure it will take up some of your free time but it will probably be one of the most awarding activities you can invest your time in.
We have all worked hard for the money we have saved and it would only be prudent to invest in in the best way possible.
With public pension systems crumbling around the world because of ageing populations, making the most of your savings had gotten much more important.
Below are the advantage I have come up with. If you have any to add please send me a short note.
1. You can wait
As a private investor you can wait for attractive investment opportunities to present themselves. If you cannot find anything attractive you can stay in cash.
Fund managers do not have this luxury. They have to invest in whatever their investment area is irrespective of valuation.
Holding cash in the fund management world is known as career risk as the fund manager runs the risk of falling behind his peers or his benchmark. The larger the cash position the higher the career risk.
The best example of career risk I have read is value fund managers losing their jobs because they refused to buy internet shares during the internet bubble.
2. You can invest anywhere and everywhere
As a private investor you can invest in any type of asset in any country that offers an attractive risk return trade-off, be it corporate bonds, equities, options, real estate etc.
Fund managers have to stay within the fund's investment area. Additionally complying with regulations, even further limits their investment choices.
You can argue that you can change to a fund in another investment area but that is also actively managing your money.
3. You can invest in any size
This is similar to the investing anywhere and everywhere as you have the freedom of investing in small or large companies whatever is most attractively priced.
I was recently astounded when I heard of a value fund manager that had to invest in companies that have a high weighting in a particular share index because he had institutional investors (read large investors) that would withdraw their funds should his performance deviate too much from the market.
This is ludicrous, why invest with a value manager if you really want market index performance? You want a value manager to do what he does best, search for undervalued companies.
4. You have no benchmark
As a private investor I only have one goal in mind, to grow my investment portfolio each year irrespective of what the market does.
I do not consider it a good year if I have lost 25% while the market has lost 40%.
I am sure your goal is the same.
Fund managers only have one goal, beating his benchmark irrespective of absolute return. I cannot remember how many times I have heard a fund manager say that he has to remain fully invested in his investment area as that is what his investors expect of him.
Just think of what happened to investors in technology funds as the internet bubble deflated.
5. You can focus and ignore
Studying, understanding and applying what has worked in investing is all you need to do to be wildly successful as a private investor.
You can only focus on a few things and ignore the market noise, you only have to spend relatively little time to be successful.
Fund managers have to have an opinion on a lot of different investment areas because they have to appear competent in company and client meetings. It is tough for them to have to say I do not know.
I do not watch financial television, its complete rubbish and a waste of time. Mainly yo-yo news i.e. what went up and down.
I have my investment criteria, I look for companies that falls within it and I study only that. The rest does not interest me and that saves a lot of time.
6. No conflict of interest
This is a big one. You only have your best interests at heart. In other words all your decisions are in your best interest.
Fund managers have to think of keeping their jobs, increasing their assets under management and keeping clients happy.
All this means is that their investment performance is not the most important thing on their minds.
Also fund managers in companies what also offer investment banking services may be pressurised to buy securities of investment banking clients irrespective of investment attractiveness.
7. You can have a long view
According to a study by the New York Stock Exchange the average holding period of shares held by investors have declined from five to six years in the 1950's to 11 months.
That means that the average investor has an investment horizon shorter than one financial year.
It is unlikely that a company with problems, as undervalued investment inevitably have, can sort them out in such a short period of time.
As a private investor you can follow the company over many years and realise the gains when the company gets revalued by the market.
This may be the largest competitive advantage you have. The ability to look at a company solely on valuation and keep it as long as it is undervalued.
8. No peer pressure
Accept if you discuss your investment with friends or family you will have no peer pressure to buy or sell any investments.
I have gotten to the point that I am reluctant to discuss my investments because the response I get is either, “never heard of it” or “what, you must be mad, don't you read the newspaper?”
Fund managers have a different problem. The funds they manage get compared to benchmark indices and other funds, including the individual fund holdings. Should you stand out in any way invites questions. Should the performance be worse than the peer group or benchmark career risk increases.
If you manage your own money you have none of these problems.
9. You decide
You make the final decision after you have done the analysis. You may be wrong but at least you make the calls either way.
A lot of funds are managed where committees decide what is bought and sold. Apart from the problems of group-think investment committees are staffed with people throughout the organisation with different investment approaches, not all of which has shown good historical results.
Furthermore it may be difficult to tell your boss that his investment idea stinks if you have your bonus evaluation later that day.
This leads to suboptimal and sometimes completely dysfunctional decision making.
10. You can concentrate
If you find a really compelling idea you can choose to invest as large a part of your capital as you feel comfortable with.
With 80% of non-market risk diversified away with as few as 15 positions you can determine what your optimal number of investments are.
Mine is 30 as I feel comfortable with the weighting of each position in my portfolio and I can easily keep track of the investments.
When I see funds with 100 or more investments my first thoughts are that they must not have much conviction in any of their ideas.
Also with so many positions you may as well buy the market itself through an inexpensive exchange traded fund.
11. You control the costs
Controlling costs and fees, or the friction of investing, is a very important part of part of realising superior long term results.
Using a discount broker I can buy and sell most shares for around 1% brokerage. If I hold a position for three years that equates to 0.33% per year plus a 0.25% custody fee.
That is a lot lower than funds that charge 1% to 1.5% per year on top of a 5% initial fee and other expenses.
Calculated over a period of 20 to 30 years keeping costs low makes a huge difference.
12. Down years are more bearable
This goes along with the point on making your own decisions.
Should you have a bad year at least you know you made the decisions, can learn from your mistakes and make adjustments to your investment strategy.
13. You can be fully invested
Should you find a large number of attractive investments you can be fully invested and remain so even if the markets declined and you are still convinced of the investment case of each investment.
With a fund manager this is unfortunately not the case. When markets fall they are bound to get redemptions. In order meet the redemptions they must either have cash available or sell investments.
But when markets are falling liquidity drops as well. That means that because investments have to be sold liquid investments are sold first. This selling pressure puts pressure on share prices leading the markets to fall further thus triggering more redemptions. You get the picture.
Some fund managers plan for such eventualities be keeping a certain amount of liquid investments or by keeping at least a small amount of cash on hand.
This as mentioned in one of the points above leads to suboptimal investments not necessarily the managers best ideas.
Luckily as a private investor you do not have this problem.
I always keep a cash reserve of one years living expenses aside to ensure that I do not have any pressure to sell investments should the market decline unexpectedly.
Also a large cash reserve gives me the peace of mind and opportunity to focus on investing for the long term.
There are of course a few funds where the drawbacks mentioned below do not apply but they are in the minority. The large bulk of fund management companies are focused on growing the amount of money they manage, where maximising the returns to investors come a distant last.
Tim du Toit
Tim du Toit is the editor and owner of Eurosharelab. He has more than 20 year of institutional and personal investing experience. Tim is based in Hamburg, Germany. More of his articles can be found at http://www.eurosharelab.com
