Saturday, September 15, 2012

The Edge of Small Investors

The title of the post might raise a few frowns among equity investors. “How can a small investor have any edge?” is a natural question that comes to mind. A small investor is generally the last one to get a piece of any actionable information. You must be thinking what way a small investor is better placed over big institutional guys who are armed with all their degrees, research teams, models and analytical tools. Let’s look at the issue in a bit more detail and how a small investor has some advantages:
  1. Small investors do not have any rules or binding criteria imposed on stock selection, like stock should be above a particular market cap, so much maximum to a particular sector, not to exceed 5%-7% to a particular stock etc. She is free to pick a stock that suits her the best, no artificial rules to play on.
  2. Let me give a small example how this rule criteria works against an investor. I study a micro-cap with market capitalization of Rs 100 crore and am reasonably sure of its business prospects and future growth, so I Invest in it. Normally a mutual fund will not invest in companies with such a small market capitalization. Same stock grows manifold in a couple of years. Now, having grown 8 times when the same stock is not such a compelling buy, it will come on the radar of mutual funds and institutions.
  3. A small investor can make all her equity allocation to just 2 of her highest conviction stocks and construct a portfolio. Can an institutional fund manager do so? I am not suggesting strategy of having a 2-stock portfolio even for a moment, but putting a point in favour of a really concentrated portfolio in case investor is really sure of the bets.
  4. Returns are often made when good stocks are held for long time, notwithstanding temporary blips and periods of underperformance. Formal fund managers have to mostly mimic or outperform their benchmark index or peers quarter on quarter, and year on year. If there are long periods of underperformance against benchmarks and peers, fund manager’s bonus and incentives shall suffer and the job can be on the line. Small investors do not have any such compulsions and can decide to hold or sell as and when they please depending on their own review and conviction.
  5. Size of the portfolio need not be a handicap for small investor. It is easier to find stock ideas with smaller sums of money of say half a million than say when you have a billion to invest. Generating double digit returns on such large portfolio sums is a daunting task for institutional managers.
  6. It’s not just performance pressure on formal fund managers that can be a drag. There are also issues of redemption pressures just when the fund manager does not want it, that is bear phase of the markets. Many subscribers get scared of equities at the wrong time (read bear markets) and start making redemption requests when they should actually be buying. But those are the classical investing mistakes on which a fund manager has no control and the Fund has to simply redeem. On the other hand, a rational small investor can avoid such mistakes. She can add to her position at such depressed times.
  7. Lastly, small investors do not have any committee to report to while making buy-sell-hold decisions. You are your own boss!
For an advantage to work in your favour, it is however, important for small investors to stay rational, control emotions and do your home-work well before making equity investments.
Happy investing!

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