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Invest Better Than the Pros?

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In “Want to Invest Like a Pro?” [4] we looked at attributes of successful professional investors.

I definitely believe one can learn a lot by watching how the pros invest. Nevertheless, I stated that following the professionals was “maybe a good plan, maybe not.”

This example nicely sums up that statement.

According to this article from The Guardian [5], a cat has managed to outperform a team of professional investors in a stock picking challenge.

Now to be completely fair to the professional investors, it was a cat and not a dog [6]. And the professionals did manage to beat a group of high school students in the same challenge. So I give them part marks!

Lest you think this a huge anomaly, there are many other examples out there. Not all involving smart cats either.

Chimps seem to do well [7]. Perhaps something to do with vodka and bankers. And I do know a British banker with identical suspenders.

Even the trusty old dart board [8] beats investors.

Why I Like These Stories

One, further evidence that stock picking is tricky. It is difficult to separate winners from losers over the short term. Even for professionals, with years of training, access to the best available research tools and data, and who analyze investments as a full-time occupation.

Two, I am not quite a Random Walk [9] guy, but I do believe that efficient markets negate quantitative analysis to a large degree. Not entirely and definitely not in less efficient market segments, so financial analysis can still add value in the long run. But when you factor in transaction costs, management, marketing, commissions, administrations fees, etc., it makes it that much harder to beat the benchmarks.

Three, cats continue to prove that they are smarter than investment professionals. As someone who has spent time with both groups, very easy to believe.

Finally, these tales provide me with much amusement. I sent the story on Orlando the cat to my nephew (who is currently studying to become a financial analyst). Now he is spending more time hanging out with Simba and Blossom than reading his finance texts.

I love it! Of course, his mother is mad at me for all the extra hairballs littering their home.

What Do These Stories Mean?

Maybe nothing, maybe something.

Limited Time Frames Mean Little

A very limited investment time frame tells us little about longer term strategies.

I see this a lot with the various investment challenges out there. Especially in universities (where I kind of shake my head). Investment challenges with a 6 to 9 month time horizon. Where the winner (or top three) get a prize and there are no consequences for finishing last.

There are always a few groups investing everything in one asset. Something leveraged, a derivative, non-diversified, etc. If they bet correctly once, they win. If not, no problem. Sort of like playing roulette in Las Vegas with house money. Why not just take the $100,000 and invest in lottery tickets?

If they really wanted to teach students how to invest (versus speculate, purely gamble), assign grades to the various quartiles at completion. Finish in the bottom 5%, get an F (or shot). Maybe have the students put in real money. Nothing like a little skin in the game to alter one’s risk approach.

Or run a simulation over multiple years based on historic data. That way investors will experience more realistic results. You might pick the right horse in one race. But to do so consistently over many races is much different.

If you are ever part of an investment challenge, two recommendations.

Bet on a non-diversified, highly leveraged, speculative single investment. You may win some money or accolades. Or you may finish last with no consequences.

Alternatively, realize that you have little real shot at winning (depending on the rules and number of participants who choose option one) and concentrate on the process. Learning how investing works may add some value in the long run.

Publicity Alters Behaviour

Publicity changes behaviour. Just watch any reality show on television. How people act in their own lives changes when it is open to public scrutiny.

I guarantee that the UK professionals did not want to lose money. So they took less potential upside to prevent an embarassing capital loss. And it worked, they came out ahead.

Had they taken on additional risk, perhaps they would have beat the cat. Or perhaps they would have lost money and been embarrassed nationally. Better to play it safe than become the brunt of jokes.

As we know, cats have no concept of shame. Win, lose, or draw, Orlando will continue to treat the human race with feline disdain.

So in the sense of time horizon and publicity potentially altering behaviour, I am not sure these type of contests tell us much about long term investing strategies.

Active Versus Passive Management

That said, it does add some fuel to the fire on active versus passive investing.

Over the course of the year, the professionals earned a paper profit of £176, a 3.52% return for calendar 2012. Good, bad, who knows? Lost to Orlando the cat, but how did the pros do versus the market as a whole?

According to the December 31, 2012 FTSE Factsheet [10], the FTSE All-Share Index returned 12.3% for 2012. That even beats Orlando’s 10.84% return. The other FTSE indices also had strong returns over 2012. Two smaller indices had returns greater than 25%.

Over this one year period, the professional investors significantly underperformed their benchmarks. That does not even factor in any fees the professionals would charge for their stock-picking expertise. And you had better believe they would be charging the same fees regardless of the actual results. In only very rare cases, some hedge funds come to mind, do mutual funds adjust their fee schedule to reflect performance (always upwards).

If the high school students had simply purchased an exchange traded fund on one of the available UK indices, they would have easily won the investment challenge. No effort on their part. Just find a broad index like the All-Share, invest on January 1, head off to the cricket pitch, then come back December 31 and collect their winnings.

Of course, if they passively invested in an index fund they would not have learned anything about the benefits of analyzing individual stocks and the investment process.

Or maybe they would. Did you?

And to my nephew, less time in the litter box, more in the textbooks, and a strong daily dose of castor oil. That will best get you ready for June.