Copycat investing

Since I’ve been writing this blog quite a few friends have asked me for investing advice. Being a conscientious sort, I’ve always felt obliged to warn them that I’m no professional and in no place to advise them. However, part of me really just wants to say: ‘it’s all there on the blog. Why don’t you just copy me?’

These days the portfolios of many smart and industrious investors, both professional and private, are no more than a few clicks away. Perhaps taking advantage of this should be part of your strategy? Especially if you have less expertise or time to spare yourself…

A fittingly plagiarised stock cartoon

There are several reasons investors don’t take as much advantage of this information as they could.

My experience is that pride can get in the way. It can be hard to admit that the ideas of others are worthy of copying, even if their track record suggests this to be the case. I’ve no doubt that I’m influenced by what other investors are doing. However, I often find myself reluctant to use this information overtly and ‘jump on the bandwagon’, even if this is objectively a good place to be. The result is often that I react to the information more slowly and less effectively than I might have done.

Part of the reason for this may be that the ethics of copying seem questionable. Most of us have been taught that copying is immoral since our early years. Doing your own research is held up as a cardinal investing virtue. Free-riding on the ideas of others in parasitic fashion is not. I think this is enough to deter many professionals from setting up funds explicitly copying one another. But should it deter individual private investors? I’m not sure it should. This isn’t the classroom – it’s not clear you’re actually doing harm by copying the choices of other investors and there are no rules against it. The information is available and it’s hard not to be influenced by it even if you actively try not to be. At the end of the day you’re still taking on the risk that the investments don’t pan out as expected.

Copying has practical limitations. Typically there will be a time lag before you are aware of new trades. This makes it impractical to try to copy investors whose strategies have short time horizons. It should work better for buy and hold. A lot of the time it will be better to just invest directly in a fund rather than try to copy some of its holdings.

The most fundamental challenge is knowing which investors to put your faith in. How do you know which investors are worth copying? Plenty of research tells us that historic performance can be a poor guide to the future as many investors experience mean-reverting returns. Judging the skill of others and then how to apply this to your own investments is an art in itself.

Crowdsourcing the best ideas

Rather than trying to identify the very best investor to copy, a better approach may be to cherry pick the best ideas across a selection of the best investors. Intuitively, this crowdsourcing approach seems like a good idea. There seems likely to be more upside where investors have more conviction, while lower conviction positions are there partly just to provide diversification.

Of course you would need to identify what other investors’ best ideas are. It’s not possible to know this for sure without talking to them. As a more practical proxy you can assume their largest position is their best idea. There should definitely be a strong correlation between the two. However, by focusing on the largest positions you may also be picking up stocks that have happened to rise the most  i.e. momentum. Unless they rebalance very actively, this may not always be the same as the stock the manager expects to perform best in the future. It may be no bad thing to capture some momentum as well but it’s worth keeping in mind that this is what you might be doing.

There is some pretty compelling empirical evidence that this kind of approach would outperform if employed systematically. A famous paper from 2005 looked at most of the fund managers in the US over the previous 14 years. It found that a portfolio composed of these fund managers’ largest positions substantially outperformed the rest of their portfolios and the stock market as a whole.

In practice I expect most investors do end up cherry picking each other’s best ideas to some extent. This may be subconscious rather than deliberate in some cases, but it’s hard not to be affected at all by the transparency of this information. So why not approach it more systematically? It would be easy to implement a strategy that does – something even an investing novice could do without difficulty.

The copycat portfolio

I thought I’d set up a dummy portfolio to see how this approach fares. My implementation is simple – I’ve spent half an hour selecting the best 25 investors I can find and copied the top position in each of their portfolios. There is surprisingly little overlap across investors, but in the few cases where there is I’ve copied the second position. I’ve ended up with 20 professionals (mostly selected from the performance tables on Trustnet) and 5 private investors I hold in high regard.

There is plenty of scope to refine this by making more careful judgments in selecting who to copy. However, in the spirit of providing an example of what a novice could do I’ve not expended much effort. I’m reasonably happy with what my slapdash effort has come up with.

The plan is to just hold these investments and then rebalance once a year by making a new selection.

So here it is. It looks like a pretty decent portfolio to me – good diversification and high quality – many of the holdings are replicated in my own portfolio or watchlist:

  1. AB Dynamics
  2. Adobe
  3. Alibaba
  4. Amazon
  5. Anglo Asian Mining
  6. Arch Capital
  7. Arcontech
  8. Argentex
  9. Berkshire Hathaway
  10. Boohoo
  11. CRH
  12. Fevertree
  13. Future
  14. Gamma Communications
  15. Games Workshop
  16. Ideagen
  17. Mastercard
  18. Microsoft
  19. MTU Aero Engines
  20. Ocado
  21. RELX
  22. Rightmove
  23. Royal Unibrew
  24. Visa
  25. Yougov

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