posted 05-19-2000 08:04 AM         

quote:

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Originally posted by hecubus:
[B]I found this link on the InvestorGuide.com homepage. It is about mutual funds attempting to be more transparent. Some of the funds were mentioned in the Tomments, but it sounds as if more are stepping into the fold.

Link[ /B]

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posted 05-08-2000 11:10 AM         

quote:

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Originally posted by slurm:
Just found this article: http://biz.yahoo.com/ts/000505/fund2_000505.html
It supports Tom's point about mutual fund managers not being very good at picking stocks.

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posted 05-04-2000 03:32 PM         

That said, I am not saying that commentators, analysts and individuals do not provide useful information. Rather, it's in how you use it. Philip Fisher, the original growth stock investor, tells of how after World War II, he decided that the chemical industry would take off. He then set out to find the one best company in that industry in which to invest. As he relates the tale, he could pretty quickly identify the top two or three prospects. Identifying the absolute best pick took months. He wanted the single best chemical company as he believed that, over the long haul, he had a 90% chance of outperforming the market with that one pick. That's much better than the chances of outperforming if you have the market's best short-term forecast. And, Fisher's investment results are legendary.

posted 05-04-2000 10:50 AM         

In the two previous parts of this essay, I investigated the various types of stockpicking 'pros' and found that for a variety of reasons their performance left a lot to be desired. Does that mean that there's no place for an individual investor to turn to get stock recommendations that are worth listening to? Actually, there's a new breed of sites that believe that there IS a place individual investors can turn... other individual investors!

Could individual investors possibly be better than the so-called experts? While the idea has met with a lot of skepticism by the powers that be, it might not be so outlandish. Consider the evidence...
- As I described in parts 1 and 2 of this essay, analysts, mutual fund managers, magazine columnists and newsletter publishers are each collectively worse than a dart thrower at stock picking, for a variety of reasons.
- Professionals used to have significantly greater access to investment information, but the internet has virtually leveled the playing field, giving individual investors the ability to research any public company very thoroughly and at no cost.
- Warren Buffett, Peter Lynch and other smart investors often say 'invest in what you understand'. There are certain people who have the opportunity to get to know a given company better than the pros: for example, that company's employees, partners, vendors, competitors, and sometimes even the users of its products.

Obviously, not all individual investors will be good stock pickers, and in all likelihood they will, on average, do about as well as the overall market. But even if individual investors as a category are poor stock pickers, as long as there is even a small percentage who are consistently good, the population of individual investors is so huge that there will be hundreds or thousands worth listening to. Of course, the key is being able to identify the consistent outperformers, so we can separate the contenders from the pretenders, which leads us back to accountability. Accountability is just as important for individual stock pickers as it is for analysts, mutual fund managers, columnists and newsletter publishers. In fact, it's probably more important, because individual stock pickers don't have reputations to protect (at least not yet).

I would like to cite evidence to support the claim that many individual investors are good stock pickers, rather than resorting to speculation, but I wasn't able to dig up the relevant statistics. This is probably because, until very recently, the prevailing wisdom was that individual investors had nothing important to say, and so it would be a waste of time to track their performance. But things are rapidly changing. Several sites do accept the premise that at least some individual investors are able to outperform the market and the professionals, and they're going to try to prove it.

iExchange is probably the fastest-growing site for stock recommendations from individual investors. Backed by internet incubator idealab, iExchange invites individuals to contribute research reports on stocks, along with target prices and dates. iExchange tracks the performance of each stock picker and ranks them based on average rate of return, directional accuracy, and predictive accuracy. What's in it for the individuals? While most of the research reports are free, individuals are able to charge for their reports if they choose to. Presumably, once a few investors have a track record of consistently good picks, other investors will be willing to pay something for research from these stock picking stars.

Validea from the Reese Group is a similar site. They also track the performance of individual investors, and they even compare individual investors to columnists and periodicals. Also, according to co-founder Keith Ferry, Validea will shortly begin tracking online computer models the same way it rates human stock pickers, so even if you're not a good stock picker, maybe the software you write will be. The site's look and feel is very professional, but the data is pretty sparse: as of this writing, only ten individuals have made 10 or more recommendations.

There are several other sites taking baby steps toward bringing accountability to individual investors. StockJungle tracks investors' picks, lets other investors rate and comment on them, and provides cash prizes for the best stock pickers. Predict-It lets individuals predict stock prices as well as sports events, political elections and entertainment happenings, and also pays cash prizes for top performers. ClearStation, which was acquired by E*Trade in March 1999, is a variation on traditional stock message boards. It tracks and displays the entire portfolio and performance for each member, so you can see who's worth listening to.

The idea of individual investor stock recommendations is certainly not a slam dunk. One major issue is whether the data these sites collect will be sufficient to demonstrate that certain individuals are consistently good at predicting price movements in the stocks they follow. As these sites grow in popularity, Statistics 101 tells us that there are going to be some strong performances even if there are no strong performers. If you fill a stadium with coin flippers, the odds are that a couple dozen will flip heads ten times in a row. If there turn out to be slightly more outperforming stockpickers than the laws of probability would predict, users will still be stuck with the problem of differentiating between the genuinely good pickers and those who got lucky.

There's an additional problem. In the mutual fund industry, investors are often encouraged not to chase last month's hot fund, because the correlation between last month's performance and next month's performance is low (or possibly negative). Mutual fund rating services recommend that investors look at a fund's long-term performance (e.g. five years), to better judge whether the fund is a consistent winner. Since these individual investor rating sites are new, it's going to take a long time before their users are able to differentiate between consistent winners and lucky guessers.

Furthermore, there's the issue of identity. These individuals don't have reputations to protect, and actually have a relatively high degree of anonymity on these sites. Are there sufficient mechanisms in place to prevent someone with a bad record from just signing up again to get a clean slate? There don't appear to be yet, and it's an issue that these sites will need to resolve if the performance data they track is to be of any value.

Additionally, some of the stock recommendations will be made by people with a vested interest, either fairly innocuous (e.g. those with a long or short position) or more insidious (e.g. people being paid to tout a stock). However, the latter can largely be avoided by focusing on stocks traded on NYSE, AMEX and NASDAQ NM. Also, such conflicts of interest are already an issue for any type of recommendation, and should be less so given the high level of accountability... it will be very easy to check a given investor's recommendations, and those that give in to such conflicts of interest will in the long run find their performance suffer and their ability to attract an audience dwindle.

There is one final issue: the government. The Securities and Exchange Commission believes (probably justifiably) in fairly tight regulation of investment advice, and may not like the idea of individuals telling other individuals how to invest. Most of these sites include disclaimers like "None of the information presented should be construed as investment advice. You are advised to consult a professional financial advisor before executing a security trade based on information obtained from this site." They do this to avoid lawsuits, but I suspect that most users ignore the warning and use the information they find as investment advice. Depending on how things play out, the SEC may decide to clamp down on individual investor recommendation sites.

Despite these obstacles, I am optimistic about the future of these sites, and I'm confident that the major issues will be resolved and that they'll become an increasingly popular way for investors to get stock research and ideas from each other. I'd like to see some of the popular analysts, columnists and other pros become members of iExchange and similar sites so they can show just how good they are. I suspect that they would be, on average, no better than individual stock pickers; and I suspect they know this, which is why they probably won't do it. But it would be nice.

Final Thoughts

In this three-part essay, I've discussed the likelihood that stock picking accountability will increase in several different categories: analysts, mutual fund managers, magazine columnists, newsletter publishers, and individual investors. Signs point to 'yes' for several of them, but not all. Would that be just a partial success? No. Those areas in which accountability increases will become more popular, to the detriment of the other areas.

What about all the conflicts of interest I discussed? They aren't going to magically go away. But they don't have to. The conflicts of interest will remain, but those stock pickers who cave in to conflicts of interest will be suboptimal pickers and their trackable results will reflect it. There's no need to address whether these conflicts of interest will be resolved on a case-by-case basis, because the resolution will be the same for all of them.

The sites I featured are taking baby steps toward accountability. I pointed out shortcomings in their strategies not to argue that their efforts won't work, but to encourage them to make improvements, and to encourage others to follow their lead, because I am confident that before too long it will work. Hopefully this essay will inspire a few more startups to take up the cause and increase the level of stock picking accountability. We plan to watch their progress, and if we find that the progress is slower than it should be, we at InvestorGuide.com will join in, because, quite simply, it makes sense.