How to Beat the Funds as a Retail Investor/Trader

You have a huge advantage!

SEE the Reality

The market is full of exploitable opportunities. A smart investor/trader will seek to maximize benefit from this with minimum effort and cost.

Size

Institutional Funds

The institutions manage hundreds of millions to billions of dollars. Companies vie for investment from reputable institutions to fund their businesses and signal their company’s worth. Brokers compete to fill in the orders of the largest institutions for a fatter commission, which is determined on a % of order size basis.

Retail Investor/Trader

You manage a tiny sum of money; a few thousands to a few million dollars worth. No company begs for your capital in the financial markets. Brokers still compete for your business, but only to prey upon you and profit from your losses.

Reality

You, the retail investor/trader are a tiny fish in a giant ocean of sharks and whales. You need to choose your arena wisely to have the best chances of winning. The large size characteristic of the institutions lend themselves to a host of other benefits:

Access to Resources and Exclusive Opportunities

Institutional Funds

They get comprehensive 100+ page reports and extensive spreadsheet models created by an army of sell-side research analysts who spend their entire careers tracking sectors and companies’ every move. These sell side analysts are at the beck and call of the institutional investors/traders. They are available to answer doubts and do grunt data hunting work; whatever the institutional investor/trader demands. The institutions also have expensive specialist tools such as Bloomberg and Capital IQ subscriptions at their disposal to streamline their work processes and present them with quick, relevant information sans the noise.

They also have easier and quicker access to talk to people in the ecosystem; customers, suppliers, distributors, competitors, company management, company employees, industry experts.

Finally, the institutions are able to dissect the pool of market opportunities into separate pieces, each managed by specialists in the asset classes or sectors.

Retail Investors/Traders

You have no such comprehensive and easy access to resources and information. And the onus is entirely on you to manage the entire pool of opportunities.

Reality

Yes, there may be exceptions where the retail investor/trader is able to have superior information access. But this is a rarity. And a sustainable, scalable and risk-responsible business model cannot be built on such rarities. The perceived reality is that the large institutions have an information edge.

Investable Opportunities

Institutional Funds

Exclusive early-bird investment opportunities at discounted prices are pitched to large funds from corporates, in exchange for their stamp of credibility in the shareholding structure.

However, due to their size, the smallest of opportunities do not see institutional interest. They do not have the bandwidth to invest in multiple opportunities that each require tiny % amounts of their overall capital base. They have low incentive to spend resources to exploit the smallest opportunities.

Retail Investors/Traders

You do not exclusive access to discounted opportunities. However, with your size, the ignored and overlooked pool of opportunities in the smallest markets; nanocaps and microcaps are ripe for the taking.

Reality

As small fish in a large ocean of whales, most waters are open and fiercely contested by your larger institutional counterparts. They have an information edge there. You have little competitive advantage in mimicking them. However, more confined waters with smaller spaces are bereft of whales and shark predators. It is here that that the retail investor/trader has a natural competitive edge.

Agility

Institutional Funds

Due to their size, the institutions encounter liquidity constraints much sooner. They are always in a fight for liquidity and sizable allocation of positions for an opportunity to make a difference to their overall % returns. The institutions will frequently take multiple days to weeks to even months to build their desired positions. Smaller, low liquidity opportunities are less worthwhile as those would have little impact on overall portfolio % returns whilst still demanding attention to manage the position. This is the real reason for why the professionals say it is difficult or impossible to time the market; they are forced to buy and sell well in advance of the big move to fill in all their orders!

Most importantly, when a collection of large institutions act on an opportunity, they leave footprints in the price, volume and disclosure data. In other words, the institutions as a whole do not operate in total privacy of their collective actions.

Retail Investor/Trader

Your smaller size in the financial markets gives you an inherent agility advantage. You can buy and sell much more nimbly with precision. Do not believe the mainstream opinion. It does not apply to you the small, retail investor/trader. You can time the market under many circumstances.

Reality

Retail investors/traders have an innate ability to move more deftly in the markets. But this great talent goes wasted if you choose to play like an institutional whale.

ACT on Opportunity

Information is only useful if it is well exploitable. Else, it is just a distraction. The institutional funds have superior information, but they have low incentives to utilize their advantage in some smaller sections of the market. They also have low agility and privacy in their moves. You, the small, retail investor/trader are built to capitalize on the weaknesses of the institutions. You may have less information overall, but you have a clear edge in exploitable power:

Tiny Stocks: An Uncontested Arena

The competitive intensity in the fight for liquidity is much smaller in the tiny stocks (nanocap and microcaps) realm. This also leads to high levels of market inefficiency, thus providing opportunity for greater alpha (outperformance).

Warren Buffett himself has repeatedly said he would play the financial markets game very differently and earn 50%+ returns by focussing on smaller opportunities if he were managing small sums:

How can you exploit the Uncontested Arena opportunity to outperform the funds? There are many ways, particularly in the Deep Value investing niche. One of my favourite ways is Net Current Asset Value (NCAV) aka Cigar Butt investing. Here’s a detailed overview of NCAV investing.

Trends & Sentiment Analysis: Easy Ride on the Institutions’ Coattails

The financial markets keep a record of price and volume transaction data. In some cases, they also mandate disclosure of institutions’ moves through filings such as the 13-F or disclose broad exposures of institutional money participants through reports such as the Commitment of Traders (CoT).

Study of these trends and sentiment signals can help retail investors/traders reliably identify accumulation (loading of buy positions), distribution (loading of sell positions) and bubble (highly unsustainable price movements) signatures of the market’s money flows. This can be used to your advantage to help you time and position yourself correctly with greater odds of success.

I will be doing a separate SEE, ACT, WIN piece to extensively discuss methods of proper Trend and Sentiment analysis in future. I promise you that this will be of immense value to you, as it has been for me.

WIN

Many retail investors/traders default to playing the markets like the institutions. Focussing on their pool of opportunities, without similar informational advantage, without exercising the agility advantage. Perhaps this used to be you…

I ask, what is your competitive edge in that game? In sports and war, home-ground or territorial advantage is highly valued. The same can apply to the financial markets. You, the retail investor/trader have an innate edge in smaller opportunities that are suitable for the size of money you manage, but is too small to interest an institutional whale. You, the retail investor/trader have a natural advantage in being able to follow the footprints of the steps taken by the institutions, after they have done all the extensive homework utilizing their information advantage.

Playing someone else’s game with inferior tools leads to mediocre results. It is now time for you to explore approaches that leverages your strengths to WIN and even beat the institutional funds’ returns!

Stay tuned for my next few articles that detail how…

Till next time,

Raj Arishtocrat

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