One of the most popular myths of the investment world is that the individual (retail) investor is at a huge disadvantage to the institutional (or professional) investor. This may have been true in the Gordon Gekko (and the greed is good) heyday of the 1980’s but with the advancements in technology during my lifetime, this is certainly no longer the case.
The invention and proliferation of the internet has allowed the retail investor to have access to announcements, company information and data at the same time as the largest institutions in the world. While, it is true that institutional investors are blessed with being able to benefit from institutional only capital raising offers and greater access to management, I believe that in many aspects of managing a portfolio does a retail investor hold a superior advantage over the institutional.
Position Sizing and Liquidity
If the John and Mary Smith SMSF has a balance of $1,000,000 and the trust deed allows for investments within small capitalisation stocks, there is a barely a stock on the entire ASX that would not provide sufficient liquidity for John and Mary to take (and more importantly) or exit a position with relative ease. In fact, if John and Mary were so inclined they would be able to invest the entirety of their SMSF into a single stock in the ASX 200 and have sufficient liquidity to do so. This obviously is not a recommended strategy but the liquidity in the market would enable them to do so.
For an institutional investor managing $1,000,000,000 this is just not possible. Firstly, should the portfolio manager find a micro cap stock that they love and their research indicates should trade a hell of a lot higher over the coming years, often due to the size of the investment they need to make and the lack of liquidity in the stock they are unable to do so. For example, if they wanted to put a 1% allocation towards a $50,000,000 company, the portfolio manager would need to buy 20% of the company! Not only would this cause a significant price increase in the share price, alerting other nimble traders but the force of the institutions own buying will reduce the potential profitability of the position. This is before we consider the risk of trying to unload a position that is equivalent to 20% of the underlying business.
Portfolio Construction and Concentration
John and Mary have the significant advantage of only being responsible for managing their own capital. This means that not only do they not have the pressure of answering to their investors (and justifying any positions that have decreased in value) but they are able to construct their investment portfolio to achieve their personal goals. Unfortunately, unless you are an Ultra High Net Wealth Individual or have an Institutional Mandate your fund manager will not be investing with your personal goals and ambitions in mind. Additionally, most individual investors and SMSF’s, tend to be relatively concentrated in their portfolio positioning. The rising popularity of Exchange Traded Funds (ETF’S) have helped to mitigate this risk but when it comes to direct equity holdings, there is a still a large degree of concentration.
This will typically increase the volatility of an investors portfolio but the trade off of this is that John and Mary are capable of having a deep understanding of their holdings. While this does not ensure that they are going to achieve Warren Buffet levels of performance, it does allow them to sleep soundly at night because they know, understand and are comfortable with their long term rationing behind owning an investment.
Whilst every Institutional investor will have their own investment style and beliefs, at the end of the day they will still be governed by their fund’s investment rules. This can be found in many forms, whether it is only being up able to hold 50 stocks, an investment universe of the ASX200 or an internal liquidity requirement. Often, these funds will not be allowed to take significant positions due concentration restrictions within the fund despite how much they love the idea or are confident in the long term performance of the company.
Tax Implications and Fees
Ultimately, when you are investing for yourself, the only tax consideration that matters is the tax that you will pay. When in investing a large investment fund, often investments will have to be sold down as a result of a significant fellow investor deciding to redeem assets from the fund. This can affect the individual as winning positions may be closed off (with tax payable) to enable the exiting investors to leave. Another disadvantage for the institutional investor is the fees that they pay. Typically a high quality manager will charge in excess of 1.10% of your investment balance plus a percentage of profits above target. For the individual investor however, the only costs they have to pay are brokerage.
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