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Why you should research small companies: IGas has made me a small fortune

igasenergyEarlier this year I tipped IGas Energy. I researched the shale situation in the UK, thought that IGas was ideally placed to benefit from shale gas exploration. I thought the shares were seriously undervalued. So I bought some at 68p.

That was April. They’ve rocketed to 129p each now.

How was this possible? I did some thorough research into a small company, that many other people hadn’t. I capitalised on information in the public domain. And profited.

The thing is, most attention in the stock market revolves around FTSE100 companies. Blue chip companies. There’s hundreds of analysts, researchers and looking into these firms.

So the opportunity to catch a big rise is unlikely. Most of the information is factored into the price, and is known by everyone.

But with small firms, AIM listed companies, opportunities are rife. Institutional investors don’t invest in small companies. Nor do they research them. So share prices don’t always reflect their true value.

So that’s where the opportunity for small investors like myself come in.

Do your research into small companies. Then buy if they seem undervalued. Boom. Profit all round.

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Posted by on January 1, 2013 in Trading Ideas

 

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INTERVIEW: How monkeys are better than fund managers – Pete Comley on his new book

Pete Comley was on his allotment last year listening to David Kuo’s podcast for the Motley Fool. The host was discussing a share trading competition for schools, and how 61 of the 72 teams had failed to beat the index.

David: “Do you know what? In the wider industry, in the professional fund management industry, these statistics are almost identical to what happens. Out of all the funds that are available for people to buy, approximately 15% of professional fund managers will beat the market, and 85% of them will not.”

As I forked over my vegetable plot, those words went round in my head. I then stopped and listened to it again. Had I heard it right – that virtually all professional fund managers, that were paid millions in bonuses – couldn’t beat the market. Surely it wasn’t true?

Over the next few months, Pete researched the industry and wrote a book about it. Indeed it was true. A monkey with a pin who picked and held stocks at random beat the majority of investment ‘experts’. Furthermore he argues that most people would be better of they just kept their money in the bank, rather than investing in funds.

Here follows an interview with Pete – you can download his book, Monkey With a Pin, FOR FREE at his website monkeywithapin.com

Meet your new financial advisor

Some people will read the book and think, isn’t this a bit grim? Because if they’re in cash they are going to be ‘financially repressed’ by inflation and if they are in shares many will pay large fees. Is there an optimistic view of what you’ve discovered?

Yes, I think there are two optimistic views on it. The first is that once you understand what all your potential pitfalls are in a trading system, you can then effectively game the system. You know where not to lose your money so you can actually be a much better trader. For example if you had just bought passive ETFs [Electronic Traded Funds which follow the stock market], and you buy and hold them, and you were confident enough that the ETF will still be around in ten years, and you picked a low-fee platform – you could keep your costs down to maybe 0.5% a year. But you have to be actively thinking about the markets and have a strategy.

The other reason to be positive, which is something I hadn’t really appreciated until I did the research, was all this stuff about cycles in the market – which I had never really sort of twigged before. Should have done, but haven’t. But I think it is quite likely that there will be some point in the next two years when the market declines to something worth buying, like the FTSE down to 4,000.

If the FTSE goes near or below 4,000 I’m just going to convert all my cash into shares somewhere, because that – if you look into history there are usually 2 or 3 significant lows in a corrective, secular bear market – and if it were to do that one [4,000], it would be the last low before we start a huge bull run over the next decade or so. I want to be fully invested at that point.

It seems as though individual investors are having to spend more time doing research into the shares to achieve better returns. Do you think there is a new gap in the market for fund managers, and people who do the research and do the legwork?

The simple answer is I don’t think there is a gap in the market. If you read the stories about a company and do the research, you will probably make the wrong decision. You remember in the book I talked about the ‘turtle traders’, the guys taught to be a bit like Eddie Murphy in ‘Trading Places’ where they took 14 people off the street and taught them to trade – and they made, whatever it was, half a billion pounds in a couple of years.

One of the key things they were taught was to effectively never read a paper. Never read a news story. Everything you need to know is in the price already, in the graph, and you just need to trade the breakouts. You just look at it and you trade the breakouts, and don’t read.

I pick up my Investors Chronicle or Shares magazine – in fact I won’t even read Shares magazine again – there’s no point, because all it will tell me is something which it is too late to invest in.

So is there a role for those fund managers [who just buy the news stories]? No, of course there isn’t. I think they will just disappear really – when eventually people realise that.

There are some people out there who are some quite clever traders – and if you want to spend a lot of time, I think you can do something and get some positive returns. But for the average Joe Bloggs in the street, it’s a waste of time. So they should go for a simple thing like passive index trackers if they want to dabble in the stock market.

But if you’re going to dabble, you still have to think about whether you should get in here or there?

I think the answer is, like Buffett, you should buy when the stock market is cheap.  I think my strategy in the future will be one of being a bit like a panther. Just sitting there in the long grass, sleeping, and when some kind of injured animal comes along, I’ll jump out and kill it and I’ll eat it and then I won’t bother to eat for a week or two. Wait for the injured prey to come by.

I agree though, timing is the difficulty – that is where you need a set of rules. For me, I see that FTSE below 4,000 and I don’t know at what point it is going to stop, but if I can get in anywhere below 4,000, I am going to be a happy bunny, long term. In the short term, I might be thinking, I could have got it cheaper, but I’ll still be happy long term, because the potential to go lower isn’t very likely. I might get my darts out as well, and pick ten shares at random – because I know how well that strategy works [i.e. the monkey with the pin]. Some of them will be dogs, but some of them will be stars. I will buy the monkey another banana.

——

At this point, I talked to Pete about the effect of benchmarking on fund managers portfolios – how benchmarking encourages fund managers to strive towards mediocrity, and to not take risks. The implicit mentality is: “if we fail, we will fail together”. The net effect is that everyone holds similar portfolios and the performance is very closely aligned. No one stands out for brilliance, nor does anyone stand out for shoddiness. For the second version of his book, Pete plans to add another section on this.

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You said managers can’t really perform consistently, so should they exist?

Well, I think that whole industry will get disintermediated. I’ve seen it in my industry, I’m a market researcher, in fact I partly helped disintermediate it. I was one of the first people doing online surveys in this country. The industry tried to take me to Professional Standards, for bringing the industry into disrepute by running an online survey. They really were fearing what it would do to their business. They didn’t in the end. Since then the industry has radically changed and the same is going to happen in the fund management industry. People have realised we don’t need most of them.

What I am expecting is that the number of fund managers will shrink substantially, I think we both agree on this, but presumably there will still be a place for good fund managers.

I think there are genuinely people out there who are better than the average and it would be great to know who they are. They are never going to be perfect all the time, but even if they can only do it better than chance, they are worth following. At the moment though there probably aren’t the incentives in the system for them to be able to follow their own real style because of the reasons you were saying. They are being benchmarked all the time. They might have a personal style like mine where they hold cash for a while, and invest at the right time. If you had that kind of style as a fund manager you couldn’t survive the system. But it probably is a more successful strategy.

You make an important point about incentives and I think that it what this industry boils down to. Because if you are an average fund manager, you just need to have an average portfolio, make it similar to your peers – then you get paid your management fee. Is the solution to this to say – you may not charge an annual fee and you can only charge based on your performance?

I agree – the incentives aren’t right. I think there is a lot of logic to that because at the moment the system doesn’t work. If they fail, the punter pays, and if the thing succeeds, the punter pays and is also charged an extra performance fee. It’s not very equal is it? They should only receive a payment if they beat the average – that would wipe out most of them.

The other point is to avoid drawdowns. For example, if a fund manager loses 50% of your portfolio like many did in 2007/8, then you need to have 100% return just to get even again. There needs to be an incentive there to limit the downside risk of these portfolios. Say, if the managers lost you money they would have to make it good themselves.

That would be nice. But wasn’t that the concept of with-profits policies? The life insurers used to sell them a decade or two ago, they said they would smooth out the returns so that if the markets turned down they would chip in some reserves. They weren’t as generous as thought because they were just pocketing most of the profits during good years – so they had big reserves to chip into during the bad years. There’s something unequal about it.

That rounded off our interview and I’d just like to thank Pete for his time and for writing his brilliant FREE book, Monkey with a Pin

 
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Posted by on May 6, 2012 in Trading Ideas

 

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Greece’s woes will tank the stock market over the coming days

Yes Angela, it is that bad

Tomorrow is the ultimatum for Greece’s private creditors, as they must decide whether to accept the “voluntary” haircut on their bondholdings. To cut a long story short, if they accept the deal they will receive unattractive, long-dated, low-interest bonds for roughly 30% of face value. Should creditors decline the deal however, Greece’s government is going to enforce Collective Action Clauses (CACs) which will force creditors to accept the terms.

So what, you say? Anyone with any sense would have dumped their bonds ages ago, and those who do hold them have largely written them off. The reason why this matters is how this “voluntary haircut” is seen by the ISDA (International Swaps and Derivative Association) with regard to CDS (Credit Default Swaps). If the CACs are activated by the Greek government, then the ISDA is expected to see it as a default – and deem that the insurers of CDS must pay out. On the other hand, if the haircut is accepted by creditors, then the CDS will not pay out.

So tomorrow is a crisis point, and the way things are looking the CACs will come into play. I am unsure of the threshold for the CACs to be enforced, but I think it is 66% of bondholders, and as of this afternoon, only 39.3% had agreed.

The problem is that nobody is certain that the ISDA will behave in this manner. In fact, if they do declare payouts, the insurers are likely to fight tooth and claw in a long legal battle to not do so. If the ISDA do not, then the parties who have insured their debts are likely to have an equally long and laborious legal battle on their hands.

The fact of the matter is, if losing 70% of your investment doesn’t count as a default, then what does? Many banks, hedge funds and investors have insured their investments with CDS and if they won’t be paid out on the Greek deal, then surely they won’t be paid if other Eurozone nations go belly up. If CDS fail to deliver, then the instruments will become redundant and fears of contagion will spread across peripheral Europe as investors will flee their positions. Bond yields will rise in the periphery, the value of those bonds will fall, resulting in major harm to Europe’s financial sector.

Wranglings about CDS, the risks of the Eurozone breakup and a potential meltdown, would make you think that the market would crash. But no, the FTSE 100 last week almost hit 6,000 and has only retreated slightly since that point. The markets seem to have totally underestimated the severity of this Eurozone crisis. If investors lose faith in Italy and Spain then we’re heading towards Armageddon scenario.

At 8:00 AM tomorrow morning sell all the shares you own. Short-sell the FTSE 100. I may of course be wrong, this process may be a slower than estimated – but it would seem that the market is a captain aware of the stormy waters ahead, but complacently sailing into them. A wreckage is not far away.

 
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Posted by on March 7, 2012 in Trading Ideas

 

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