Last weekend we had the 3rd round of the FA Cup, where top professionals compete against amateurs. In most parts of life, you would expect the professionals to beat the amateurs convincingly. However I came across a blog post by someone called the undercover fund manager, explaining the advantages that amateurs enjoy relative to professionals in investing. He admits that when it comes to investing, amateurs who know what they’re doing tend to outperform the professionals on a regular basis. I wouldn’t like to open the batting against Jofra Archer and I’m not sure Pep Guardiola has my phone number in case Kevin De Bruyne gets injured, but in investing the playing field is actually tilted to the advantage of the amateur.
This not because the professionals with large funds are dumb (well maybe Softbank’s VisionFund is dumb, but they’re the exception). The professionals are well credentialed, hard working, bright (some are rather arrogant it must be said). But if they manage an open ended fund they have to deal with constant inflows, outflows and liquidity constraints. When things are going well, the operational gearing (growing revenue on a fixed cost base) makes it a wonderful business. The reverse is also true.
It is very difficult to find hard data to support this idea that amateurs do better than professionals in investing. Most amateurs don’t have independently verified track records, and of course people who have done badly tend not to post their performance on Twitter. With that caveat, here is a sample of people I follow “@glasshalfull” up +83% and +44% CAGR in the last 10 years. If a professional was reporting that, they’d be books written about them. But he’s not alone: @MGinvestor up +47% last year and 31% CAGR over 10 years, @Carcosa up +50% @fundhunter_co +38%. Hopefully Leon Boros who won’t mind me pointing out he’s up +43% in 2020 .
The decline of the amateur investor
The hard data we do have is pointing in the other direction, showing the fall in the amount of money that people manage themselves, and instead the growth of institutional money. The ONS publishes its Ownership of UK quoted shares data report, showing that back in 1963, the man in the street owned 54% of all the shares in issue on the London stock market. Since then the stock market has become dominated by institutional investors. The man in the street is still the ultimate owner, but the institutional fund manager looks after his money, and charges a percentage some of which he spends on nice offices, staff (including legal & compliance professionals), Bloomberg terminals etc and the rest is profits for him and his shareholders.
Since the 1960s the amateurs’ direct holdings have declined to a low of 10% in 2012. But then recently from 2012 the trend has begun to recover, and individuals now constitute 13.5% helped by tools like Sharepad.
So what is going on? I think there’s a bias currently in our society towards professionalism, but this wasn’t always the case. I am listening to an account of the Everest 1953 *expedition on audiobook. All of the climbers had to be “amateurs” with occupations like doctor, statistician, British Army officer or university student; anyone earning a living as a professional mountain guide was not selected. This seems in opposition to modern values, “amateur” is often meant as an insult. “Professionalism” is meant as a compliment. Yet I think perhaps we have lost something to be admired in the “amateurs”, who have achieved much over the centuries.**
Constraints on the professionals
The constraints of professionalism mean that amateurs can run more concentrated portfolios and invest in smaller companies without liquidity constraints. The undercover fund manager points out that UCITS funds, for example, must comply with the 5/10/40 rule, which stipulates that no more than 10% of the fund be invested in a single security. Positions in excess of 5% must collectively sum to no more than 40%, meaning a fund with 6 positions of 7% each would be in violation. Compare this with my own portfolio of 23 stocks, where my top 4 holdings are currently 2/3 of my portfolio.
“Wait and hope” portfolio
If I’d re-balanced my portfolio at the start of the year so that each company was 1/23 of my portfolio, then I would have been up 5%. But because I didn’t rebalance and I’ve owned companies like Sylvania Platinum(+109% this year), Games Workshop(+81%), Impax AM(+74%) and SDI Group(+44%) for years, I actually ended up +29% in 2020.
The best investment professionals behave like amateurs
There is an irony that the best performing fund managers like Warren Buffett and Terry Smith invest in an amateurish way. Buffett famously doesn’t spend much time meeting management or forecasting earnings with a spreadsheet, which many professionals pretend gives them an advantage. He takes concentrated positions, at one point in the 1960s 40% of his fund was in one stock (American Express). I’m fairly certain that Terry Smith doesn’t spend much time on the phone to sell side analysts. Instead the best performing professionals spend their time in the same way as the amateurs who know what they’re doing: owning companies that consistently generate high returns and keeping their transactions to a minimum
*Everest 1953: The Epic Story of the First Ascent by Mick Conefrey
A version of this article appeared in my weekly comment for Sharepad
I also spoke about this at a Mello Event which is an open community for private investors
**Naturally mountaineering first ascents have be made by amateurs. But there are examples from mathematics and science: from Rev Thomas Bayes and Rene Descartes through to relativity being worked out in the Swiss patent office. When Albert Einstein became a professional academic, his productivity dwindled. The gentleman amateur has had a long innings in philosophy all the way back to Thales of Miletus. See A History of Western Philosophy by Bertrand Russell