Here’s a quote from a recent discussion:
Trillions of assets under management with teams of CFAs and yet people think their few minutes of research on yahoo finance is the same if not better.
Now, that comment is right – a few minutes of research won’t do it. However, I think it’s a bit of a strawman – I believe people who invest in individual stocks obsess about them way more than just looking at the summary page on yahoo finance for a moment (and those that don’t get failed out of the market).
Regardless, there is this general notion that you don’t have a chance against institutional investors no matter what you do. I want to express a contrarian opinion here.
Institutional investors can’t invest like you can:
– they can’t just allocate 5% of their portfolio to a new target they’ve researched last week. There is never enough volume on the market for that (go try buying a $500M stake in ZS)
– it’s even worse on the options market – the volume of options is so low that buying or selling them is a major PITA for institutional investors
– they can’t just sell reasonable fractions of their portfolios either. Even 1% of a trillion dollars under management can be hard to move
– they can’t hold a reasonable cash reserve. You want to keep 15% of your assets in cash just because you think the market is a overvalued right now? It’s extremely expensive for institutions to do that. In fact 15% cash is completely out of question for them – they have to juggle “highly liquid assets” around instead worrying they may become less liquid than expected…
– they report to their investors and may be forced to do inefficient decisions based on that – they can’t focus only on the long term
Those are all disadvantages an institutional investor has over an individual. They do have a couple of advantages as well:
– they can take over whole companies – it’s typically for a higher-than-market stock price when taking over a publicly traded company and it doesn’t guarantee good returns, but it’s definitely something you cannot do.
– they can buy privately owned companies – some of the most lucrative deals Buffett did were in private business (this does not affect you as an individual investor though)
– they can have a talk with the company’s management – with a commanding stake at the company, the C-suit is bound to listen to them. This may not always be a good thing though – stupid short-term thinking has been forced by shareholders onto companies quite often.
– they can optimize taxes better
– they get access to specialized areas of investing not available to individuals – like IPO underwriting which is typically quite lucrative or high frequency trading which is extremely technical but generates steady gains etc.
What do the highly skilled professionals do most of the time?
This might be surprising to you but most analysts in large institutions don’t analyze individual stocks. Large institutions have to look at capital markets as a whole and then spend most of the time
a) analyzing risks – the risks in their current holdings (because risks change over time), the current risks in the different areas of capital markets and potential future risks that may be coming up both in their holdings and on the market
b) formulating strategy – they’re steering a huge ship and there’s icebergs around (the risks) – they have to define their moves and start steering way ahead of an imminent danger. So once they’ve identified the risk distribution they have to decide on feasible ways of action.
c) executing strategy – here are the non-trivial tasks of managing your liquid assets, buying significant stakes in large companies (ever wonder how you could buy 5% of MSFT if they only trade under 1% of float daily?), negotiating take-overs etc.
I am not saying that they big institutions don’t analyze and invest in smaller companies but when they do, it needs to fit their risk strategy and they can only shoot with their huge capital cannons at them. Like Buffett had to decide whether to invest half a billion in Snowflake or whether to invest nothing (half a bil. is still just 0.1% of Buffett’s company). And while doing that he/his team had to consider the risk distribution of his holdings and how an investment like SNOW will change in that.
What can you do better than the pro’s?
– You can watch the companies in your portfolio/watchlist way more closely and manage your portfolio more carefully. Know the company’s plan, watch how it executes that plan, you can reallocate money from worse executing to better executing companies easily.
– have a cash buffer – it comes handy in weird market swings
– You can learn to make money trading options. This requires additional dedication but you can get a steady income stream from options if you don’t use them for gambling.
– specialize on a specific market – you may still hedge your bets, but you can gain a significant advantage if you understand a specific market well
– focus on the long term – you don’t need to abandon companies after a quarter or two of subpar results as long as their market plan still holds water in fact, you can buy more shares for a discount (some of my most lucrative buys were after well publicized but bogus short thesis on some compenies)
What can you do like the pro’s?
While you won’t ever be able to underwrite an IPO or offshore your taxes like the big guys do, you can:
– find somebody to discuss your investments/potential investments with. It has to be a specific person (or a couple of them) that you can trust and where you know how they tick. Bringing additional points of view or even going through explaining your thesis to somebody can make wonders for your gains. It doesn’t work with anonymous, ever changing internet coments that well though – people tend to pull stuff out of their asses.
– be mindful of the risks in your portfolio and learn to hedge
– understand larger capital markets and how they may influence your portfolio (i.e. my portfolio would be overvalued by traditional measures and I should sell it – but I understand that it’s because large investors lost opportunities in other capital markets and are forced to jack up stock prices)
Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence or consult your financial professional before making any investment decision.