Really?
This post was originally presented in BeyondETFs Pro in August 2019.
Further to our series of Tips on avoiding common mistakes in investing, here are three surprisingly common mistakes that professional portfolio managers make and how Beyond ETFs subscribers avoid them. In The Only Thing the Smart Money is Smart About, a July 12, 2019 article by Jason Zweig of the Wall Street Journal, timely research flags the most frequent mistakes that professional portfolio managers make.
As you might expect, there are academics and professional service firms that analyze portfolio behaviors to give professionals private feedback on their decisions. And as Jason explains, professionals differ from retail investors only by the fact that the professionals get paid handsomely to do what they do!
Professional investors hold stocks too long.
According to the research, roughly half of the percent-of-assets-fee is cost associated with holding stock past their prime. This issue is called endowment effect by psychologists. One automatically puts a higher value on the things you own than the things you don’t. So, despite bad news, professionals often hang onto a stock longer than they should.
Subscribers sell a stock as soon as it enters the Avoid Zone, regardless as to whether it has been a big winner, or a big loser. That’s because the next highest stock in the Buy Zone has a higher price momentum and therefore represents a better opportunity than the potential return of hanging onto a stock in the Avoid zone. (Despite the temptation).
Professional investors have a low price per share bias.
Consider two companies with same market capitalization, yet one has more outstanding shares, so it trades at a lower price per share. The same wonderful news – new CEO, new product, important settlement – contributes the same value to the success of each firm, yet the one with the lower price per share will likely experience a greater bump than its higher priced peer.
This low price bias is measurable and true even in investment firms with high institutional ownership. “Investors are telling themselves this news is worth $1 per share”, regardless of the number of shares.
Subscribers trade based on the price momentum of the stock, which accounts for bias and other human distortions of the market in the relative rankings.
Professionals purchase one stock when they meant to buy a different one.
A study comparing 250 companies with similar names or tickers, estimates that 5% of the total trading volume of these companies are cases of mistaken identity. These mistakes are made by both retail and professional investors. And to make it even worse, computer-driven trading systems notice the spike in trading volumes of the wrong company and jump in to catch a further uplift, albeit temporary, and only for a week or so.
In the Beyond ETFs approach, it is the subscriber making the trades. Communications in the Zone Changes report refer to companies only by their symbols, which reduces the risk of subscribers mistaking Helmerich & Payne Inc (symbol: HP) for Hewlett Packard Inc (symbol: HPQ).