Move to the Edges

Few would argue that Sir John Templeton was one of the greatest investors of the last 100 years. He racked up a great track record over his very long career applying the principles of value investing on a global basis. From inception in 1954 until 1992 when he sold his firm his flagship Templeton Growth Fund earned an average annual return of 14.5%. An investor who put $10,000 into his fund on day one and simply held on while reinvesting dividends would have cashed out with more than $2 million dollars. Over the course of his career Si John put together a list of 22 investing maxims for investors to use in the search for above average returns. Two of them stand out as being of particular use for individual investors: It is impossible to produce a superior performance unless you do something different from the majority If you buy the same securities as other people, you will have the same results as other people. These two maxims are particularly timely as the deadline of 13f filings is coming up on the 15th of this month. These filings are required by the SEC and money managers have to file with the agency revealing all of their holdings as of the end of the quarter. Astute investors have learned to use this as the world's smartest research department y comparing new filings to previous ones to see exactly what some of the best fund managers in the country are doing with their money. Being able to see what great investors like Seth Klarman, Warren Buffett and Michael Price are buying and selling can be a tremendous source of ideas and best all these smart people basically work for you at no charge. Although the filings are not due for a few days yet many are starting to come in already and browsing them at random can also give us great insight into why most investors, individuals or institutional have such a hard time beating the market. Go to www.sec.gov and search for 13f filings. Click on a bunch of them randomly without looking at the name and the problem becomes quite clear. Everybody owns the same stocks. A huge percentage of the filings show that most of the professional money managers are basically buying the stock in the major indexes and just tweaking the percentages of shares owned. How can you outperform significantly or consistently if you own the same stocks everyone else owns? It seems that beyond designing derivatives to blow up the world there is very little original thought on Wall Street. This carries through to most individual investors as well. If you talk to 100 different investors you will find they all own the same stocks as the institutions with a strong bias towards larger well known stocks that get a lot of media coverage. Owning stocks that everyone else has heard of creates a false sense of security and prevents investors from earnings higher returns. We know from the work of folks like Cliff Asness of AQR that the excess returns are out on the edge of the markets and not in the middle of the pack. Momentum strategies based on both price and earnings momentum tend to outperform over time. So do value strategies that focus on paying low prices to book value and earnings. Buying the large stocks in the middle does not produce excess returns and you will not outperform the market by owning them. They are the market. The price and earnings momentum strategies can be difficult to replicate and the people with strong record of success a this approach like Louis Navellier and Charles Driehaus use very sophisticate models to track fundamental momentum. If you have a strong mathematics background and the ability to withstand the higher volatility that comes along with this approach it might be one for you to consider but most individuals will find it hard to put into practice. For most individual investors who also have careers, families, and interests beyond staring at a computer screen tracking stocks all day the value approach might be a better alternative. The two strategies share some common traits. Both will usually be investing in smaller stocks much of the times. Institutions that wean to be the biggest of the bunch simply cannot invest in these styles. In order to preserve their stream of fees they have to move back to the middle of the pack and hope they can tweak the S&P 500 weightings a little better than the competition. Individuals do not have the same issue so they are free to select the style that suits them best and focus on the smaller companies that offer the best opportunities for profit. If you look in your portfolio and seethe same stocks that everyone else does and are frequently mentioned in the media you are giving away your biggest advantage as an individual investor. The higher returns are out on the edges of the market in either momentum or value stocks and that is where you should be focusing your attention.