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How to become your own investor by Peter Leahy

It’s no secret that investors have struggled to beat the market since the start of the financial crisis, but with the ‘glory days’ for hedge funds set to resume, your manager may be about to enjoy a much better deal from your investments than you are.

Their fees typically run at what’s known as ‘two and 20’ – meaning you’re charged an annual fee of two percent of the money invested – whatever happens – along with 20 percent of your gains. While the performance fee isn’t charged in periods when the value of your fund declines, it does kick in again once the previous ‘high water mark’ has been reached. With equity market indices at all-time highs, now is a good time to check on exactly where you stand on this point.

While inquiring about fees, it would also be wise to ask about the performance of your fund. Keep in mind recent news about spectacular losses at some funds and consider that the odds may well be stacked against you. If you’ve beaten the odds and been fortunate enough to win, remember you may only enjoy 78% of the potential profit the market is offering (100% minus 22%). But if you’ve lost out, you’ll be effectively waving goodbye to a good part of your money – and paying an additional two percent for the privilege.

A recent report from Standard & Poor’s showed that actively managed funds last year lost ground compared to funds that merely tracked (ie. mirrored) the market. In 2012, 63% of large-cap funds, 80% of mid-cap funds and 67% of small-cap funds underperformed the respective indices.

All of which begs some questions: are you getting value for your money? Could or should you try and do it for yourself? Is there any logic behind the notion that you could replace the underperforming ‘experts’ without paying their fees and perhaps do a better job? It is possible but it’s not a task to be taken lightly. While there’s unlikely to be a lack of motivation in seeking to generate a profit with your own money, there are some basic principles you need to consider and incorporate into your strategy:

1.     Good sailors follow momentum
It’s a piece of advice that billionaire hedge fund manager John Paulson should’ve heeded. In seeking to reverse two years of losses in some of his strategies, his Gold Fund last month lost 27% of its value, bringing this year’s decline to an estimated 47%. But rather than admit defeat, he’s still talking up its potential. Most investors would follow the will of the market and sell, but large corporate funds like his can’t change the label on their box.

2.     Be small and nimble
To trade in amounts that will make any difference to a large portfolio, the big managers need to transact in bigger volumes than you or I do. This can be like turning an oil tanker. You or I can usually move in or out without moving prices against us, in fact I usually judge the size of my deals according to this consideration.

3.     It’s not just what you buy but when you buy and sell it
Successful investors are expert at managing their own financial emotions. Buying a share on someone’s say so, or allowing someone else to take all the decisions can lead to costly and therefore disheartening mistakes. We’re all human and subject to emotions, but to be successful you need to manage those that can trip you up. Avoid those hazards that could make you dis-heartened and despondent.

4.     Do your own research carefully
Rely mostly on your own research: analysts, dealer firms and stockbrokers are locked into a complex political nexus you don’t need to be part of. With a few keystrokes it’s now possible to bring up years of financial information and filter for your chosen criteria of, for example, earnings per share growth histories for listed companies across the globe.

5.     Cut your losses
An unsophisticated idea, but you don’t have professional pride to deal with! You’re not being paid big fees to do this and you really don’t always ‘have to be right’ and nor should you expect to be. My own rule is never to take more than an eight percent loss unless very exceptional circumstances apply. Why? Well we’re back to psyche here: wishful thinking replaces logical reckoning somewhere around the eight percent loss mark.

6.     Question the need for a ‘balanced’ portfolio
Why buy things you know very little about? Avoid complexity and too many holdings, there will be too much to keep your eye on. It’s a simple enough task to allow a software package to generate a classic balanced portfolio, but the problem is that not only will it lead you into unknown areas, by following the pack you’ll limit your creativity. Specialise in what you know best.

7.     Understand crowd behaviour and technical analysis
The use of technical analysis remains deeply unfashionable among the institutional (ised!) intelligentsia, many of whom view it as very ‘low brow’. Savvy and highly successful private investors use technical analysis to look for relevant patterns: a build up of fear or greed, tipping points and dams at bursting point. They are very useful way of reading momentum and probability: successful investors know that you ignore this information at your peril!

Peter Leahy Peter Leahy is an experienced investor and trader, having worked for 30 years in the investment sector. He’s worked for J.P. Morgan, Hoare Capital Markets, Bear Stearns and Kleinwort Benson, but more recently founded the Sovereign Leadership Group. He runs specialised training courses about the financial markets. His clients are a mixture of companies working in the financial services sector – senior professionals within the industry – and members of the public.



For more information, contact Peter directly by phone on +44 20 7978 0589 or by email.

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