These Three Things Give You An Edge Over Big Money Managers

These Three Things Give You An Edge Over Big Money Managers
Jonathan Hobbs

9 months ago5 mins

  • Professional fund managers might have a lot of resources and expertise behind them, but they’re also restricted in a few ways. You don’t have those same restrictions, which gives you an edge over them when investing for the long run.

  • You don’t have strict investment mandates and regulations telling you what you can (or can’t) invest in, nor the career risk associated with underperforming the benchmark in the short run.

  • You’re also moving much smaller amounts of money than a big fund. And that makes it a lot easier for you to be agile with your strategy.

Professional fund managers might have a lot of resources and expertise behind them, but they’re also restricted in a few ways. You don’t have those same restrictions, which gives you an edge over them when investing for the long run.

You don’t have strict investment mandates and regulations telling you what you can (or can’t) invest in, nor the career risk associated with underperforming the benchmark in the short run.

You’re also moving much smaller amounts of money than a big fund. And that makes it a lot easier for you to be agile with your strategy.

Professional fund managers have a lot going for them when it comes to making sound investment decisions. Not only do they have impressive credentials and market experience, but they also have teams of analysts doing tons of heavy lifting. It’s no wonder, then, that so many investors are happy to hand their cash to fund managers – and just let them get on with things. But if DIY portfolio management is more your style, here are three things that could give you an edge over the big dogs.

1. You can play by your own rules.

There are two kinds of fund managers: passive managers, who’ll track a benchmark index (like the S&P 500), and active managers, who’ll try to beat the market by cutting their own investment path. Thing is, even those active managers have to follow strict investment mandates that govern what they’re allowed (and not allowed) to do.

From a regulatory side, mandates make a lot of sense. After all, if investors are handing over their money, they’ll need some kind of assurance that the fund manager is going to follow certain rules while handling it. With European UCITS funds, for example, fund managers can’t invest more than 10% of any fund in a single stock – even if they’re convinced it’ll outperform the rest of the market.

Most funds will also have limits on how much cash they can hold at any time. So even if the managers think prices are headed lower, they’ve still got to invest most of the fund’s cash right away. And that means the fund could end up with less dry powder to take advantage of better bargains later on. This gets even harder to deal with when funds get fresh injections of money from investors and are expected to put it to work immediately – regardless of the state of the market.

The manager of a value fund, for example, might have a problem buying high-flying growth stocks after a big market pullback. But you, yourself, could have (in theory) been sitting in 30% cash for most of last year, and then bought Tesla for just $100 a share in January. You could also have bought bitcoin for $16,000 in December – all without the compliance headaches that go with it for those pros. Long story short: you have way more flexibility than most fund managers, and that can be a huge advantage in volatile markets.

2. You can take a longer-term view with your investments.

There’s a lot of pressure for active fund managers to beat their benchmarks every year. If they fall too far behind them, they’ve got to explain to their investors (and employers) what went wrong. That kind of short-term career risk doesn’t exactly go hand-in-hand with generating stellar long-term returns.

For career stability, it’s OK for a big money manager to be wrong, so long as everyone else is wrong too. But it's usually not ok if a professional investor takes a big contrarian bet that doesn’t pay off – and quickly. That’s why a lot of the pros tend to hug their benchmarks, rather than completely ignore them and build their own strategy from scratch.

In Andrew Craig’s book How To Own The World, (which I highly recommend you read), he writes about fund manager Tony Dye, better known by some as “Dr. Doom”. Dye was one of the best in the business in the 1990s, but he refused to jump on the dotcom-hype wagon with everyone else. He thought tech stocks were way overvalued, and his fund’s performance fell behind the competition during the final stages of the tech melt-up. Dye lost his job a month before the dotcom bubble burst – even though his analysis was spot-on.

As the manager of your own financial destiny, you only have one person to answer to: yourself. And that means you can invest for the long term, and ignore what everyone else is doing in the short term.

3. You’re not a whale.

Big funds have far more capital at their disposal than your average retail investor does. So whenever they buy or sell in size, they need a lot of liquidity on the other side of the trade to soak up their orders. That’s usually fine when they buy or sell highly liquid stocks like Amazon or Apple, but it can be a nightmare if they’re working with smaller stocks that aren’t traded very often. In that case, the fund can end up with excessive “slippage” fees when it trades.

If a fund manager tries to buy a big position in a less-liquid stock, for example, it would have to fill all the sell orders that are staggered at higher prices. And by the time the buy order actually fills, the fund would’ve bought the stock at a much higher price than it bargained for. It’s the same when it tries to sell a big position and there aren’t enough buy orders to match the sell order at the higher price.

Slippage costs add up over time. And huge funds have to scale in and out of big positions over many orders to keep those costs down. But as a smaller-fish investor, you don’t have to fret about moving the market every time you do business. And that means you can get in and out of an investment much faster than a whale. And in the current choppy market environment, that could be an advantage.

So, what’s the opportunity then?

Sure, you might not have the investment knowhow of a seasoned fund manager. But you can be a lot more agile, flexible, and contrarian with your investments than most of them. You can also build a portfolio across a much broader range of asset classes – and tailor your exposures to match your own conviction and long-term investment goals.

But if you’re a contrarian investor who still prefers to leave it to the professionals, there might be a middle ground. You could opt to invest a portion of your cash in active funds that aren’t afraid to do their own thing. Cathie Wood’s ARK Innovation ETF (ticker: ARKK; expense ratio: 0.75%) springs to mind here – it’s currently trading 74% below last year’s peak. Or, if you’re based in the UK, you could check out the Scottish Mortgage Investment Trust (SMT; 0.32%) – it isn’t too shy about taking long-term bets either. Not only is SMT trading 55% below its 2022 peak, but its discount to net asset value is currently around 15%.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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