Should you follow the investing gurus?

Big names don't necessarily mean big returns.

Andrew Hepburn 17 March, 2017 | 5:00PM
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Turn on the financial news and you may encounter a bold forecast from a reputed investing guru, like a newsletter writer or a famous hedge fund manager. Or you may read stories, based on regulatory filings, about how a large fund has taken a big position in a stock. The question is, should these proclamations and reports influence your own portfolio decisions?

Before answering this, it's worthwhile to recall a famous scene from The Big Short, based on Michael Lewis's bestseller of the same name. It's March 2008, and legendary fund manager Bruce Miller is facing off against housing bear Mark Baum on a conference panel about the mortgage market. Baum predicts doom while the optimistic Miller reiterates his bullishness on investment bank Bear Stearns, which was heavily exposed to subprime bonds. During the debate, Bear's stock plummets an astounding 38%. Informed of this during the Q and A, Miller suggests he might buy even more.

We all know what happened to Bear Stearns.

Bruce Miller is actually based on a real person: Bill Miller. And for an incredible 15 years (1991-2005), Bill Miller's Legg Mason Value Trust fund beat the S&P 500 index. It's easy in hindsight to watch The Big Short and see Miller's folly in holding Bear Stearns stock, but at the time, he was an established guru. Based on his stellar long-run track record, it's understandable that an investor might have used Bill Miller's investments as the basis for his or her own portfolio allocations.

Speaking of the financial crisis, those investors who became stars by betting against the U.S. mortgage market didn't all continue their winning ways. John Paulson, to name one, made billions off the meltdown, but subsequently has seen his own hedge fund suffer heavy losses and client redemptions.

What lessons can be drawn from Miller's experience with U.S. bank stocks, and Paulson's stumbles post-crisis? For one thing, nobody, no matter how smart, is right all the time. To quote the fine print of all mutual fund prospectuses, past performance is no guarantee of future results. Second, it's very difficult to predict when a star manager will come back down to earth.

At least some people (such as Bill Miller) have enviable track records. What's striking about many so-called investment gurus is that they don't seem to be any more accurate than a coin flip. A study by CXO Advisory Group, a research firm, looked at approximately 6,600 public forecasts on the U.S. stock market by 68 supposed experts. Their work estimated the accuracy rate of these "gurus" at 47%. In other words, they were slightly more likely to be wrong than right.

Mind you, the CXO research only looked at forecasts; it did not track the performance of actual positions taken by investment firms or well-known individuals. Large hedge funds and mutual funds often have to make disclosures when they purchase shares of publicly-traded securities. For this reason, the financial media and investors often scour regulatory filings to see what these influential players are buying and selling. In theory, this should help the retail investor, because it allows them a glimpse into the thinking of ostensibly more sophisticated market participants. It also should be more useful than forecasts, because you'd expect smart investors not to be very vocal about all their brilliant ideas.

Alas, you have to treat these reports with a certain degree of caution. First, public filings on securities acquisition and disposition are not real-time data; they can be delayed by a few weeks or a few months. And this matters if you're trying to copy the investment style of the big players, because by the time you see they've bought a stock, they may have already sold it or be in the process of liquidating the position. Second, in the case of certain investments, it's possible that a big fund has offsetting positions you are not privy to that make their public filings incomplete at best.

For instance, let's say a big hedge fund reports that it has taken a substantial position in a bullish oil ETF such as BetaPro Crude Oil 2x Daily Bull (HOU). From this information, you might conclude that they are optimistic about the price of crude. However, the manager may also own derivatives that will pay off handsomely if oil plunges, and maybe the oil ETF holding is a hedge against the bearish bet -- so the overall positon is not nearly as bullish as the filing suggests. In fact, it could be structured such that it's biased to the downside. But you, the investor, only see the bullish side of the picture, because the derivative holding may not have to be disclosed.

Notably, the experience of one exchange-traded fund suggests that following the big money does not appear to pay off for investors. Back in 2012, the Global X Guru ETF (GURU) launched in the U.S. with the stated mission of providing investors access to some of the best ideas of hedge funds. The ETF tracks purchases of stocks by funds and mimics their activity. It did rather well in 2013, gaining more than 47% and outperforming the S&P 500 by 15 percentage points, but it has badly trailed the benchmark since then, and its risk-adjusted long-term performance currently lands it in 1-star territory.

So, when a famous investor or pundit makes a market prediction, should you ignore it altogether? Not necessarily. But rather than the forecast itself, it's important to consider the arguments put forward by the "guru" in question (if they give a public explanation). Most crucially, you should avoid buying or selling something simply because of what someone else thinks. You might take their opinion into account, particularly if they have a good track record, but you should always try to do some research of your own. Finally, investors should avoid becoming overly concentrated in a single stock owned or recommended by a guru. For all you know, the one you pick could be a laggard in the guru's own portfolio.

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About Author

Andrew Hepburn

Andrew Hepburn  Andrew Hepburn is a freelance financial writer based in Toronto. He writes about investments, market trends and personal finance. He has written for Maclean's, the Globe and Mail, and Canadian MoneySaver.

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