The Huge Advantage You Have Over Institutional Investors
Most investors think they are at an extreme disadvantage when it comes to investing in stocks.
They would argue that the institutional and hedge fund manager has advantages in terms of resources, access to company insiders, and a whole team of analysts, dedicated to selecting stocks.
While that might appear that way on the surface, the individual investor is able to neutralize those advantages…and even has a leg up on the institutional investor.
Before you dismiss the idea that you have the edge, keep this in mind: Only a small fraction of mutual fund managers outperform the S&P 500 over a five-year period. If the institutions held all the cards, a larger percentage of them would outperform the benchmark on a more consistent basis.
In fact, the opposite is true.
The approach we take offers us an edge that most mutual fund managers, hedge funds, and institutional investors do not have: a concentrated portfolio, no restrictions
on holdings and the luxury of time.
I always question how good a mutual fund manager’s 85th best idea is. By law, fund managers must diversify their holdings, very often keeping less than 1 percent in any one stock. Instead of knowing much about a few companies, they try to know a little about many. A widely diversified portfolio (100+ holdings) proves to be a recipe for mediocre performance.
In contrast, our portfolio holds a concentrated portfolio of no more than 30 stocks. By sticking with our best ideas purchased at attractive prices, our portfolio has done very well over the long term. In fact, it has outperformed the S&P 500 by a wide margin.
But do keep in mind that over the short term and during rising markets, we run the risk of looking silly as our holdings are priced based on their popularity with investors and not their intrinsic value. We will accept looking silly over the short term and being right over the long term any day of the week.
Most mutual fund and institutional managers have built-in restrictions as to where they can invest. A mutual fund, for example, has a clearly defined mandate, which is, many times, based on industry (e.g., technology), market cap (e.g., small caps), or region (e.g., global companies).
If there are stocks trading outside these areas for 10 cents on the dollar, the mutual fund manager is prohibited from buying them. In contrast, we are limited only by our ability to find value. If we can’t find value, we will wait patiently, and lower our buy trigger to valuations we believe offers us a margin of safety.
Luxury of time
Institutional investors are usually compensated on an annual basis. They do not have the luxury of buying and holding for the long term, and that is why they focus on a company’s quarterly results. To qualify for their bonuses or incentive fees, they need to outperform their benchmarks over short-term time horizons. Their concern is not how the company will perform over the next five to ten years but how much the stock price will move over the next 90 days.
Our advantage is that we view short-term price fluctuations as meaningless and we make decisions based on the outlook of the business. We spend our time researching companies, trying to figure out how they will continue to increase their market dominance over the long term instead of trying to guess what their earnings will be over the next quarter. Our goal is always the same: buy great businesses when they are selling for attractive prices.
Time is the friend of a wonderful business. It’s the enemy of the lousy business. If you’re in a lousy business for a long time, you’re going to get a lousy result. Even if you buy it cheap. If you’re in a wonderful business for a long time, even if you pay a little too much going in, you’re going to get a wonderful result.