Should You Follow the Pros?

In my last post, I indicated that investors should normally not compete against professionals.

That does not mean you cannot rely on their skills in an attempt to enhance your own portfolio returns. In fact, many investors follow analyst recommendations and/or invest in mutual funds that are actively managed.

Whether this is a prudent investment approach is something we will look at.

As in all walks of life, some analysts and fund managers have better track records than others. If you intend to rely on their advice or investment decisions, you should try to find the ones with proven track records.

Mutual Fund Managers

We covered the key areas of consideration in a couple of previous posts.

Please review “Mutual Funds: Management” for suggestions on assessing fund management.

To try and separate the upper tier managers from the lower tier, I suggest using the recommendations contained in “Mutual Funds: Performance is Relative”.

Keep in mind that past performance is no guarantee of future results. A manager’s prior results may be suggestive of the future, but many other variables can impact the actual results.

Investment Analysts

Assessing an investment or research analyst is quite similar to evaluating a mutual fund manager.

As in “Mutual Funds: Management”, you want to know a little about the analyst you are interested in following.

How long a history does she have as an analyst? What are her technical credentials? Does she have experience in her area of research? For example, the analyst may have 10 years of experience analyzing European bonds. This may be good if she is still rating bonds. But it may not be a good sign if she is now analyzing Australian mining companies.

How has the analyst has performed in both bull and bear markets? When the markets are up, it is relatively simple to see one’s picks rise in value. But how did she do when the market as a whole fell? That may tell a different story.

You might also want to know the analyst’s financial interest in the recommendation. This can be a two-edged sword though. On the one side, it is nice to see the analyst own the securities she recommends and is putting her own money into the investment. On the other side, perhaps there is a conflict of interest if the analyst has a financial stake in the investment. That is, maybe the security is being recommended in the hopes that individuals will read the positive review, put their own money into the security, thereby driving up the price and enhancing profits for the analyst.

And exactly as in “Mutual Funds: Performance is Relative”, how did the analyst perform compared to her peers and any identified benchmarks?

Note that there may not be any associated benchmarks with selections of individual securities. However, that does not mean you cannot create your own as an assessment tool.

I would suggest something simple. For example, if the analyst is rating Swiss equities, the Swiss Market Index (SMI) might be adequate. The SMI holds the 20 largest stocks in the Swiss equity market.

Or you could use a number of other Swiss indices depending on your investment criteria. The SMI Mid (SMIM) that holds the 30 largest Swiss mid-cap equity stocks not included in the SMI. The SMI Expanded includes the 50 stocks that comprise the SMI and SMIM. And the Swiss Performance Index is Switzerland’s overall stock market index. And that is only a few indices from Switzerland. There are others you can use based on your needs.

Definitely not a perfect match as the risk-return profiles may differ. But a good starting point.

Next week, we continue our look at whether you should follow the investment professionals. We will consider whether investment analysts provide positive net returns to investors.