VR Logo

The Little Guy vs The Big Guns

Can the small investor learn from the way large institutional investors manage their investments

The Little Guy vs The Big Guns

Can an individual investor, who only has time to look at his investments once in a while, have anything to learn from a professional investment manager? More interestingly, can an average individual investor be as good at investing as a full-time investment manager? Generally, such questions are answered anecdotally, as in 'yes, so and so knows a guy who always makes so much money on stocks'. Or, it's a sales pitch from someone who wants to charge you money and promises to make you a great investor.

However, even if such examples are accurate, I'm not talking about either of these. Obviously there are individuals who are outliers and have sustained success at investing. There are also plenty of services that at least promise to make a great equity investor. Still, the fact remains that a vast majority of small investors do badly in their efforts to make money on equity investments. They act on the advice of those whose interest lies solely in telling them stories and making them transact, because that's the way for the advice-givers to make money.

Some days back, I came across a book that's a most interesting comment on this whole business. It's written by a man named David F. Swensen, who is one of the successful institutional fund manager in the world. For more than forty years, he has managed the endowment fund of Yale University, growing the fund from $1.3 billion to $25 billion over this time. Over the last three decades, it has generated average annual returns of 14 per cent per annum in a country where much less than that level would be remarkable. This is a fund that has to earn continuously as large sums of money is taken out of the fund every year for the university's expenses.

The interesting thing is that about ten years ago, Swensen set out to write a book for the individual investor. His idea was to show how the 'little guy' could do as well as the big guns, to do what he does at Yale. The book was intended to show people like us how Swenson invested, and how we could also do what he does. It seems that unlike most business or investment book writers, Swenson went through the whole process honestly. On the way to completing the book, something surprising happened. Swenson came to the conclusion--unexpected for him--that the little guy couldn't actually compete. Much of the advantages that he had as an investor with tens of billions of dollars came from his scale and the resulting special treatment he got.

Except that even this isn't actually true. While some of the investment avenues and the way of investing in them may be available only to big institutional investors, the same is not true of the underlying principles. Those are available for everyone to use, and for free.

Swenson's investments are fiercely diversified, with allocations to various investments allocated carefully and then rigorously rebalanced. The diversification is at the asset class level as well as at the level of actual investments. Sounds like a simple thing, but it's the key to being a successful investor. It's also something that individual investors find impossible to achieve while picking and choosing stocks directly. This underscores the one important piece of advice that Swenson has for the small investor, which is that individuals shouldn't pick stocks themselves.

Diversification, deliberate asset allocation, and proper rebalancing. These principles of investing are best applied through a mutual fund. From his perspective of a US investor, the obvious choice is that of using an ultra low cost index fund as the basic unit of investment. While the logic works somewhat differently in India, where plenty of active funds routinely beat the markets after costs, the principles stay the same. So can the little guy beat the big guns? The answer is it doesn't matter because it's not a competition. If you can apply the same principles and get the same advantages, then that's good enough.