We’re all individuals

Market Folly (HT Abnormal Returns of course) yesterday wrote an interesting post about the benefits for a promotional company management of having a “prominent investor”, a Buffet, a Paulson or some bigtime hedge fund operator to give his imprimateur of approval, viz:

It only takes one stamp, and poof, their image is revamped and a tiny sense of confidence is restored. That’s the power a prominent investor can have on a company’s market image. They can turn heads, begin to sway market sentiment, and start to change the negative perception. . .

Jay, MF’s proprietor, is quite right, of  course. Not so long ago one of Baruch’s stocks doubled on the day Warren Buffet took a stake in it, and for no other reason. But it is a regrettable tendency.

Baruch’s professional life is founded on the principle that markets are really not efficient and that inefficiencies persist. One of the way in which they do, I am convinced, is this burning desire people have to follow what they perceive to be “smart money”. Baruch’s rule is never, ever, ever buy a stock just because someone else has. That doesn’t mean not being aware of who owns what; that’s often key information (and MF is invaluable for that), especially if you know they’re in trouble and their money is being taken away. And Baruch has to admit that after having done the work on a stock and finding Fidelity is following you in on it can give a certain gratifying warmth, and is often worth about 20%

But there are many ways in which following “Smart Money” into stocks in an unexamined way will get your faced ripped off. Here are just a few:

  • Timeframe: you have no idea how long that investor will be in the stock. He could only be holding out for a 30% gain for instance, and in the lag between when your hero got in and you found out about it, it might have gone up 20%. He may already be on his way out. If it’s gone down, he may have stopped it out already. And then why were you in it again?
  • Why is he actually in it? What if it is not an alpha position, rather  a hedge to offset a short, which is where your hero thinks he’s going to make his real money? What if he has offset it with an option position and is not, in fact, net long at all? Again, the disclosure that some guy has this stock on his books may mean very little. And think hard about why he may have told people he likes it? Pump and dump, baby.
  • What if your investing guru is not actually that smart? Howard Lindzon doubts that smart money actually exists, and I believe him. Buffett followers took a bath recently; anyone who followed disclosures in the big hedge funds last year lost money with them. By the time an investor has become one of “The Smart”, it’s often a very good time to get off the bus; these things move in cycles, as the Ancients knew well. I had a great year in 2007 and looked like a genius. If you had invested alongside my end 07 disclosed positions in 1H 08 you would not have been so pleased. Plus you ‘d have still been in as I was getting out. Hell, you’d have been buying the stocks I was selling!

Uncritically following other investors is not just intellectually supine, craven and inherently lazy, I think it is responsible for the “crowding” phenomenon which contributed to the collapse of hedge funds in 2008. Walk among their circles in mid 2008 and all you would here about was “Maverick’s big in X” or “Viking loves Visa” and in many cases this was enough for the others to get in too. Now, it’s all about avoiding “hedge fund hotels”, especially on the short side. Tracking others’ investments is downright unfashionable.

Basically, the message is, do your own bloody work, and lots of it. Stock market investing is a deeply deeply subjective game, and pretending it can be objective and labour-free is the path to leveraged explosions. It’s subjectivity is at the core of the whole pricing mechanism. You are smart money, or have the potential to be if you concentrate on what you know and can know with more work. If you can’t do your own work, invest in a fund or do something else with your money, real estate or hell, I don’t know, vintage cars or something.

7 responses to “We’re all individuals

  1. Unfashionable as it may be to track what noteworthy investors are doing, I strongly posit that the intelligent spec should always at least try to structurally understand who/why something is/has done what it’s done. This is no substitute for doing as you term it, “one’s homework”, but is importnant since in many cases, particularly where prior returns has been excessive in either direction, as a factor driving forward returns over the short to mid interval, it swamps long-term fundamentals.

    Moreover, since returns are reasonable zero-sum, the most apt advice with regards to the knowledge factor of “who is doing what, when”, is that The Simpson’s character, Montgomery Burns, who proffers: “…keep your friends close and your enemies closer…”.

    • Cassandra dear, I know it would be great to be able to strategise about the movements of large and noteworthy pools of capital in particular stocks, but in most cases you’re on a hiding to nothing. You just don’t have any real way of knowing, bar scurrilous and unactionable gossip, what the big guys are doing and why. It’s a brain suck, that way lies madness. You’re much better off thinking about their depreciation schedule and working capital.

      Now there are cases, specifically when there is some activist schtick going on, when it is important to know what particular funds are doing, and what they’re thinking. Normally they help you out with this, however, writing open letters to management and giving interviews in the press. The holdings are big enough to be disclosed.

      But for the rest of the time, I fear you would lack the information to make thinking about who and why, in terms of specific investors, worth the bother. And in the more liquid stocks, even if you could find out reliably, it wouldn’t be that important.

  2. Monty Burns, seen here planning a corner in a highly-shorted “rubbish-stock”. One large strategic spark is often all it takes to set the tinder alight…

  3. Yes Baruch, I agree wholeheartedly that the wrong kind of study can leave one looking up one’s own @rse* (metaphor attributable a Scouser flatmate from uni days who as it happens was pursuing a philosophy degree).

    However, categorization is everything. Knowing in aggregate what is NOT held by hedge funds gives insight into aggregate short positions; knowing that in aggregate that certain positions have systematically been liquidated gives insight into idiosyncratic component of returns; Seeing that Fidelity has alreadyaccumulated a >15% position over the past three or four quarters with mondo price impact says the fat tail of forward return is likely to have a negative sign – at least in relative terms. And so on. In isolation, it’s a fools game, but in combination with other factors, they (not the chinese whispers, but the aggregate quarterly or periodic filings and aggregations thereof) are useful telltales, a position I sense you will not dogmatically argue to the contrary.

    • Ha, your senses fool you Cassandra, I WILL dogmatically argue to the contrary.

      I can’t make any conclusion about price direction after Fido has taken a position. I could equally conclude that where Fido goes a mess of wanna-be “individuals” in the monty python vid above are going to pile into the stock. What if Fido had taken its sock in a block and hadn’t affected day-day liquidity? I could argue that Fido tends to hold on for the long term and that stock got taken out of circulation semi-permanently, a great bullish signal. What if it wants 20%, not 15%? I could equally think as you did that it would be bearish. I would sit there, thinking about it, weighing second and third deriatives (what if Fido only wants me to think it likes the stock?). My head would disappear up my arse. Meantime the working capital modelling of the stock in question would go undone; I would fail to notice that receivables and inventories shot up to the moon, and would be blown up next quarter as the company admitted they had been making it all up all along.

      OK, maybe I exaggerate for the sake of a decent argument. It IS useful, I know, but just not very, at least for me. And I admit I am always curious to know who owns what; I just don’t think of ways to use the info usefully. I know there is more than one way to skin a cat, and there are as many ways to make money in stocks as there are profitable traders. Probably lots of them look at who owns what as well. Is that what makes them profitable, however? Who knows.

  4. hey thanks for the link and elaborating on our piece. You bring up very prudent points and I think I’m going to pen a response on the blog because I think you’ve touched on a great topic for discussion. After all, we started our blog to keep tabs on all the big money since it is worth at least knowing where they are investing, as you point out. But, many people indeed follow this money in search of returns.

    I’ll post up a response here in a few days hopefully once I get my thoughts in order. Thanks, love reading your stuff.

    Jay

    • Hi Jay! I’ll look forward very much to your thoughts on this. It is an interesting topic, isn’t it?

      In fact after my discussion here with Cassandra, rhetorical flourishes aside, I find my positioning softening somewhat. I still think uncritical, slavish emulation is an investing sin, but what sort of serious investor really does that ? Stockjockey of 1440 Wall Street reminds me of a post I wrote late last year about hedge funds and finding out what they hold, in order to take advantage of the structural stress in the hedge fund industry and forced redemptions. It struck me that the inverse could also be true — when you know someone is about to get tons of money, and are likely to add to their favourite holdings, why not hold “uncritically” a basket of stuff you know they already own?

      Obviously, in either case, one would be a fool not to consult Market Folly!