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.