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Cloning investment ideas; issues for the small value investor.

To the retail value investor keeping up to date on the portfolio holdings of superinvestors like Warren Buffet, Seth Klarman, Daniel Loeb and Bill Ackman is an important part of the investment process. Intelligently cloning ideas from the most successful in our craft is an excellent way of achieving above par results. The whole strategy has been explained most succinctly by it’s biggest cheerleaders Mohnish Pabrai and Guy Spier who can elaborate much better than myself on the merits of this strategy.

 

Some potential pitfalls:

 

Big Investors buy Big!

If we believe that cloning is a great way for finding new investments so do many other investors. One of the biggest issues with this strategy, as I see it, is the ideas that are being cloned are mainly those from these large investors and so the companies are generally huge. If you need to deploy a large amount of capital smaller stocks are by necessity going to have to be off your radar screen. Small retail investors have a great advantage in that they have the ability to invest in companies of virtually any size and value opportunities among smaller companies have a greater ability to outperform their larger peers over time.

Guru Investors are cyclical themselves!

A point that I feel is very important but has had little or no attention is that different value investors follow different strategies to each other. Websites that track their portfolio holdings are more likely to include those managers that have had a good run over the last few years. Outperforming managers may also attract more clones eroding the discount at which one is able to buy the idea.  Over time different value strategies will do better than others depending on the cycle so be aware of past performance bias when looking for opportunities. Warren Buffet has changed his strategy over time and throughout those different periods he has been outperformed at certain times by different notable managers.

Don’t miss out on cyclical industries!

Another issue that I find is that many of large value investors constrain their investing universe to industries and geographic area. A quick look on Dataroma.com (an excellent resource) will show largely US focused stocks with the same names cropping up in many portfolios. There does also seem to be a bias towards large high quality “compounding machine” type businesses which have proven themselves over time. Larger investors favour these types of stocks as they can hold them for long periods of time without selling and will benefit from the amazing effects of compounding. The smaller investor has a greater ability to invest in cyclical industries and extremely depressed companies which can outperform these compounders over smaller periods of time with less thought to liquidity needs and daily trading volume.

Retail investors are biased when cloning stocks from Superinvestors.

A further hurdle for small retail investors is their own biases when cloning superinvestors. Some of the best returning equities in the large investors portfolios are the ones that were bought when the company or industry was truly despised, they may also have averaged down into the position initially taking losses. When a small investor sees that their hero has taken large losses on an investment they may be more likely not to invest even if the stock has the ability to outperform in future.

The big boys have to think about political risk and reputation.

Superinvestors these days have to be careful when investing in politically or socially problematic situations. The tobacco industry, gambling and jurisdictions such as Russia may offer tremendous value time to time but large investors can take heat from all sorts of directions if they hit the bid on these types of investments. As a retail investor you are less likely to get a phone call from the state department if you start piling into Gazprom and you are not going to have enraged activists calling your office if you own a coal miner. By sticking to cloning you may miss out on some of these opportunities.

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