Author Topic: The Four Types of Advantages in the Financial Markets (My Thoughts)  (Read 4853 times)

innerscorecard

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I thought the following (from the shareholder letter of Anabatic Fund LP, a small fund managed by Philip Ordway, who is a relatively young guy who I don't know is actually good or not) was a reasonable summary of the kinds of advantages you can have as an investor. I'm going to post the excerpt and then my own thoughts on how this applies to Mustachian individual investors:

Quote
Informational advantage – In the search for attractive investments it makes sense to look under as many rocks as possible. Building a large and diverse business reference library – both the physical and the mental variety – is also important. Along the way an opportunity may occasionally pop up in a small company or security where very few other people are paying attention. As Paul Sonkin, a wise and successful investor, once said, it definitely helps to “fish deeper [and] fish alone.” There is also some advantage to be gained by making one last phone call or reading one last document, and there will never be any substitute for doing the homework and knowing the facts. But it is hard to capture a meaningful advantage in an age with almost limitless information available at the touch of a finger to virtually everyone. Thorough informational research is critical to investment success but it is insufficient on its own.

Analytical advantage – Once all the information about an investment has been gathered, it is crucial to run it through the right filters. I began by learning, as most people do, about the traditional quantitative methods for security analysis that have stood the test of time. That process is invaluable, and the resulting analysis should hold its own against anyone else’s. An analyst should be able to present to the board of directors with credible knowledge and insights, and a bull should know the bear’s argument at least as well as he does. But that level of analysis is the standard, not a point of relative advantage. A bigger advantage probably comes from a range of qualitative factors that might govern the outcome of the investment. Once the fact pattern is in place, what are the psychological forces and people-driven influences that might be masking the truth? This second stage of analysis is especially helpful in avoiding mistakes, and avoiding mistakes is perhaps our single biggest advantage over time.

Behavioral advantage – This is a crucial component of investment success but also the hardest to define and measure. We have to be both different and prudent, exercising an intentional but cautious contrarian streak. We have to be willing to sit on the sidelines when the party is roaring and also willing to act aggressively when times look tough. The biggest profits are made – and biggest losses are avoided – by a willingness to steer well away from the crowd, especially when there is a strong consensus about the right thing to do. An intent to stick to our knitting and avoid dumb, herd-like behavior is a simple strategy, but it’s not always easy in practice. Discipline rules the day.

Structural advantage – Our fund comprises a group of like-minded and patient partners who understand our strategy. The fund has low fees, it avoids leverage, and it has a flexible mandate to pursue opportunities wherever the market offers them without regard to annual benchmarks. Investments are made in a concentrated fashion based on their intrinsic value, and they’re often held for a period of years. None of those features may seem remarkable on their own, but taken together they nonetheless yield considerable results over a period of years.

I'm not sure if Philip, his fund, or his investors in fact have any of the advantages he listed. I don't know one way or the other. But individual investors, especially frugal and efficient Mustachians, should.

Informational advantage - None to negative, typically. But conversely, the realization that one is disadvantaged can actually be an advantage, when others aren't as willing to admit this.

Analytical advantage - Typically none, with the caveat that as an individual investor completely outside of the financial community or world, you may be more likely to think in a truly contrarian way.

Behavioral advantage - Potentially huge. When you are already used to living day-to-day using a different mindset from most of society, you already have a huge edge. Most people aren't wired to be different. But those who are can definitely benefit. So much effort is expended on avoiding volatility. If you can actually handle it, you gain a lot. No need to expend resources on hedging and other trade-offs, for example.

Structural advantage - The big, big one. Having no outside investors besides yourself, no management watching over your shoulders, no negative publicity, and no artificial limits on what you can do is a big advantage, whether you are just indexing or whether you are picking individual securities.

It's really quite nice being an individual investor. It's business-like investing (in the Graham and Buffett sense, of owning pieces of individual companies), which makes you rich over time, without all the institutional nonsense. And in your tax-free Roth IRA, you don't even have taxes getting in the way.

arebelspy

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Re: The Four Types of Advantages in the Financial Markets (My Thoughts)
« Reply #1 on: January 20, 2015, 11:38:38 AM »
I liked that. Thank you for sharing.
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RapmasterD

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Re: The Four Types of Advantages in the Financial Markets (My Thoughts)
« Reply #2 on: January 20, 2015, 01:17:25 PM »
LINK: http://www.beyondproxy.com/four-types-advantage-selected-company-updates/

This looks like the complete article. Interesting musings. Thank you for sharing.

innerscorecard

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Re: The Four Types of Advantages in the Financial Markets (My Thoughts)
« Reply #3 on: January 21, 2015, 01:44:43 AM »
Thanks. The reason I posted this is because people on this forum (and other retail investor forums) are always talking about how many advantages professional investors have over them. It's true. They have a lot of advantages. But individual investors have very strong advantages too, especially when it comes to disciplined, long-term investing.

milesdividendmd

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The Four Types of Advantages in the Financial Markets (My Thoughts)
« Reply #4 on: January 21, 2015, 02:20:15 AM »
This is an interesting post.

The low hanging fruit is behavioral.  If we can figure out a strategy not to get in our own way we will have beaten 80% of investors out there institutional or otherwise.

And another structural advantage of being an individual investor is that there are little to no impact costs. Even if we invest 100% of our portfolio in one small Cap company, our purchase will not stand to move the stock price in any meaningful way, (as opposed to an institutional investor moving billions.)

marty998

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Re: The Four Types of Advantages in the Financial Markets (My Thoughts)
« Reply #5 on: January 21, 2015, 02:32:29 AM »
Sounds like a classic contrarian strategy.

They just need investors patient enough to tolerate long periods of underperformance until the markets go haywire every few years and their strategy comes into its own.

arebelspy

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Re: The Four Types of Advantages in the Financial Markets (My Thoughts)
« Reply #6 on: January 21, 2015, 07:43:29 AM »
If we can figure out a strategy not to get in our own way we will have beaten 80% of investors out there institutional or otherwise.

Speaking of which, is there a way to automate your latest investing strategy (dual momentum)?  (Or a dual momentum ETF or something like that.) Otherwise I see behavior still getting in the way.  Even a written plan can be hard to stick to when TSHTF; automation helps a lot.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
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milesdividendmd

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Re: The Four Types of Advantages in the Financial Markets (My Thoughts)
« Reply #7 on: January 21, 2015, 08:20:24 AM »

If we can figure out a strategy not to get in our own way we will have beaten 80% of investors out there institutional or otherwise.

Speaking of which, is there a way to automate your latest investing strategy (dual momentum)?  (Or a dual momentum ETF or something like that.) Otherwise I see behavior still getting in the way.  Even a written plan can be hard to stick to when TSHTF; automation helps a lot.

I'm sure there is, but I'm not computer literate enough to write the code. Maybe I should get my 13-year-old son on it?

It wouldn't be that much harder than writing an algorithm for monthly rebalancing.(You'd just have to add a step for backtesting.)

Long term, no matter the strategy, investing success is largely about avoiding behavioral errors. And I tend to agree that the more active one is, the greater the risk for behavioral error.

arebelspy

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Re: The Four Types of Advantages in the Financial Markets (My Thoughts)
« Reply #8 on: January 21, 2015, 08:35:18 AM »

If we can figure out a strategy not to get in our own way we will have beaten 80% of investors out there institutional or otherwise.

Speaking of which, is there a way to automate your latest investing strategy (dual momentum)?  (Or a dual momentum ETF or something like that.) Otherwise I see behavior still getting in the way.  Even a written plan can be hard to stick to when TSHTF; automation helps a lot.

I'm sure there is, but I'm not computer literate enough to write the code. Maybe I should get my 13-year-old son on it?

It wouldn't be that much harder than writing an algorithm for monthly rebalancing.(You'd just have to add a step for backtesting.)

Long term, no matter the strategy, investing success is largely about avoiding behavioral errors. And I tend to agree that the more active one is, the greater the risk for behavioral error.

How are you planning on doing it then?  Manually? And how often?  Weekly?  Monthly?  Or does Betterment offer Dual Momentum Automatic Rebalancing?

EDIT: Link for everyone else: http://www.milesdividendmd.com/two-faced-investing/
« Last Edit: January 21, 2015, 08:36:53 AM by arebelspy »
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

milesdividendmd

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Re: The Four Types of Advantages in the Financial Markets (My Thoughts)
« Reply #9 on: January 21, 2015, 09:45:31 AM »
I do it manually each month.

Just a simple backtest on perfcharts on the last day of the month.

(http://stockcharts.com/freecharts/perf.php?).

Due to the selections in my retirement accounts I only toggle between S&P, EAFA, and short term treasuries.

I haven't made a trade yet in the last 6 months. (100% long S&P)

(I use betterment for my taxable accounts only.)

hodedofome

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Re: The Four Types of Advantages in the Financial Markets (My Thoughts)
« Reply #10 on: January 21, 2015, 12:06:38 PM »
I spoke with a broker a few years ago that will execute your strategy for $25/trade...

milesdividendmd

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Re: The Four Types of Advantages in the Financial Markets (My Thoughts)
« Reply #11 on: January 21, 2015, 12:29:57 PM »
At that rate should be <$25 dollars/year, but what's the point?

I enjoy the process and look forward to the end of the month each month.

innerscorecard

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Re: The Four Types of Advantages in the Financial Markets (My Thoughts)
« Reply #12 on: January 21, 2015, 07:08:30 PM »
As I said on Twitter, I think you will definitely end up doing well...unless you discover "something better" in a few years and then switch strategies.

I personally think that you will be more likely than not to stick with it, based on what I know of you. Most people (even most doctors) probably can't. But that's why it works, because most people can't stick with it. If they could, it wouldn't work.

hodedofome

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Re: The Four Types of Advantages in the Financial Markets (My Thoughts)
« Reply #13 on: January 22, 2015, 07:54:54 AM »
I do it manually each month.

Just a simple backtest on perfcharts on the last day of the month.

(http://stockcharts.com/freecharts/perf.php?).

Due to the selections in my retirement accounts I only toggle between S&P, EAFA, and short term treasuries.

I haven't made a trade yet in the last 6 months. (100% long S&P)

(I use betterment for my taxable accounts only.)

Here's a Google Finance spreadsheet I use to track the past performance of several ETFs and Mutual Funds. You can copy the rows and columns and put in whatever stocks/ETFs/mutual funds you want. You can look at the past month/3 months/6 months/9 months/12 months or an average of all. Unfortunately Google Finance doesn't give out of the box formulas for tracking those timeframes on mutual funds...they only do 4 week(1 month), 13 week (1 quarter) and 52 week (1 year).

I don't believe Google Finance incorporates dividends which can make a difference. I personally use ETFReplay.com as they incorporate dividends, however the data isn't refreshed until about 8pm Eastern each night. At least with Google Finance it's 'realtime' - up to 20 minute delay.

https://docs.google.com/spreadsheet/ccc?key=0AjyyTlvGE-T2dFFfWTJCNTctUE5lQ1Q0b1BRcG45dFE&usp=sharing

hodedofome

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Re: The Four Types of Advantages in the Financial Markets (My Thoughts)
« Reply #14 on: January 22, 2015, 08:00:15 AM »
At that rate should be <$25 dollars/year, but what's the point?

I enjoy the process and look forward to the end of the month each month.

Yeah I was kind of joking about the broker. $25/trade might be cheap for a strategy that doesn't trade much, but most of the strategies they run might have a hundred trades or more a year. I believe it's a better comparison of paying hedge fund fees vs paying a broker to trade a hedge fund strategy for you. At a certain asset level, it may make sense.

FWIW this is who I spoke to, Shane was actually a pretty decent guy on the phone, though I'm like you in that I want to trade my own strategy because I enjoy it. http://www.wisdomtrading.com/