Serious Money: Can the individual investor hope to compete with the professionals? Is it worth the effort? asks Chris Johns
The average fund manager these days has studied for a post-graduate professional qualification, devotes most of his waking hours to thinking about financial markets, has access to more information than he could possibly assimilate and is advised by countless numbers of people working even longer hours in brokerages and investment banks.
The small investor, sitting at home with the financial pages of the newspapers, looks to be at a hopeless disadvantage.
The latest trends in professional fund management look set only to widen the information gap: asset management is becoming a "quantitative" game, where huge data sets are crunched through increasingly incomprehensible mathematical models. These days, if you understand the latest developments in non-linear mathematics you either join the military or set up a hedge fund.
The fact that fund management is becoming more professional is undoubtedly a good thing. Too many institutions used to advertise in their marketing literature a detailed "investment process" that was largely ignored.
In practice, that investment process sometimes amounted to a bunch of people sitting around a table on a Friday afternoon sharing each other's prejudices and hunches about what was likely to go up or down the following week.
To be fair, some people are actually quite good at this sort of thing, but not very many, and certainly not enough to justify the fees that fund managers charge retail investors.
The various investment industry scandals - mostly in the US but also one or two that took place in Europe - have contributed to the demise of the old-fashioned way of doing things.
These days, if you don't have a well-articulated investment process you are not in the game. And, if you fail to adhere to that process, you run the risk of being sued by disappointed customers.
Whether or not all the new investment technology leads to better performance remains to be seen. In the bad old days, the Wall Street Journal used to run a competition between various analysts and fund managers and a monkey: the professionals used their models to pick winning stocks, the monkey threw a dart at the stock listings of the newspaper.
Suffice it to say that the monkey won the competition so many times that it became embarrassing. Would the outcome of such a contest be any different today? I have my doubts.
The fund management industry faces a paradox. Taken in its entirety, the global stock market is owned by the global asset management business. The fund manager is the market.
Looked at this way, the professional asset manager can never hope to beat the market; it is an arithmetical impossibility. He simply replicates the market's performance; he is the ultimate index tracker. When you throw in an average fee level of, say, 3 per cent, his performance will be whatever the market does, less 3 per cent.
In total, the fund management industry is guaranteed to underperform the market. The larger the fee structure, the bigger the underperformance. Of course, some managers might consistently do better, while others always do worse. For the retail investor, the game is one of manager selection.
Given the amount of professional intellectual effort being devoted to the investment decision it is a big call to decide to do it for yourself. But technology is available to help those who are prepared to make the leap. For those who have neither the time nor the mathematical inclination to compete head-on with the model builders, there are still several potentially profitable avenues that can be followed.
Keep it simple. Devise a system that is manageable, particularly from the perspective of time. A few simple rules and a relatively limited universe of stocks should be chosen.
That means staying close to the Irish market and, perhaps, some familiar names overseas. The investment rules that you choose will be key to future performance.
You could, for example, choose between various investment styles: growth or value investing are two of the most common approaches, each has a distinctive set of investment criteria (with some blurred edges that sometimes lead them to overlap).
You might decide to invest in companies that meet certain valuation criteria; technical analysis or "charting" may play a role. Whichever way you go, this is where the initial homework gets done. Help is at hand: the old-fashioned way to get to grips with all of this material would be to buy a book and/or do a course. Alternatively, websites exist that can guide us through all the necessary material.
An excellent example is the site constructed by one of the leading academics in the field, Aswath Damodaran. His site is comprehensive and can be found at pages.stern.nyu.edu/~ adamodar/. In future articles, I will explore some of the different investment philosophies and approaches used by the professionals but anyone who wants an excellent overview of the field - and much else besides - should look at Damodaran's website.
So much for theory. Other web-based resources include the free material provided by brokers. For the Irish market, daily updates are supplied by all the main firms and are handily grouped together by RTÉ and can be found at www.onbusiness.ie/brokerreports.html. Another excellent free site, giving a good daily overview of all of the macro or big-picture issues confronting markets can be found at www.morganstanley.com/GEFdata/digests/latest-digest.html.
At this stage, it would be easy to launch into a long list of the ever-expanding free resources available on the Web. But the risk of drowning in information overload is high. My favourite is uk.finance.yahoo.com, a resource that is remarkable for being both extensive and free.
Reuters supplies an overview of analyst thinking on various companies: go to www.reuters.co.uk/financeQuotes.html, type in Bank of Ireland (for example) and just see the wealth of material that is available.
Other sites worth a look include www.bloomberg.com/markets/ europe _index.html and www.fool.co.uk.
For those, like me, who are sad enough to find this kind of thing fun, I can offer no guarantees. But my hunch is that a little work will pay dividends.
