Monday, December 15, 2008

Watching What Fund Managers Are Buying And Selling

Buying Australian shares has taken nerves of steel in recent times. All of the major Australian stock market indexes have spent most of the year in a decline that has ranged anywhere from a steady fall to alarming drop depending on the prevailing mood in world financial markets.

Australian investors need all the help they can get. Could keeping an eye on what the professional fund managers are buying provide you with some clues as to how to invest your money? While institutional investors don't always get it right I think watching what shares the managed funds are buying and selling can be a useful exercise.

I tend to use this information in one of two ways.

Identifying Investment Opportunities:

The first way I use this information is as a way of finding new shares to invest in. I should stress at this point that just because a fund manager is buying shares in a particular company, does not mean I would automatically go out and but that stock. Investing money in something just because a leading fund manager is buying is not a good way to make money, in my opinion.

What I tend to do is research the company in more detail and apply my own quality and valuation criteria to it. Look at earnings and dividends. Does it have low debt? Does income cover the interest on borrowings with a sufficient margin? Does it have a good return on invested capital? And so on...

In most cases, I cant make a compelling case to buy shares in the company and I move on to the next opportunity. It doesn't mean the stock wont go up - it just means that I can't find any reason to buy based on fundamentals.

Because of the resources available to most institutional investors, they are more likely to spot opportunities before I do. In this way, a number of situations have come to my attention which I would otherwise have missed. It's normally after a sudden share price drop that a situation like this presents itself.

As Part Of My Investment Research:

The other way I use this information is as a kind of a sanity check when I'm doing my research. When investigating an investment opportunity, I normally have a look to see who the substantial shareholders are and who has been buying or selling lately. While it's not normally a deciding factor, if I see that one of the better Australian fund managers has been buying, it would strengthen the case. Conversely, if I see that some of the best performing managed funds have been selling, it would raise a red flag and cause me to dig a little deeper. But, just because they are selling, doesn't automatically mean the company is a poor investment. You don't know why they are selling.

How To Find The best Fund Managers:

This is a difficult question. If you're going to spend time watching a professional you'll need to make sure it's someone worthwhile. Perhaps the best indicator is the fund managers performance over an extended period of time - preferably through both bull and bear markets. Look for consistent performance as measured against an index like the All Ordinaries or the ASX 100 (or some other appropriate sharemarket index) or against other managers with a similar risk profile.

The other thing to look at - and I think this is just as important as performance, if not more so - is their investment style. Do they buy growth stocks or are they a contrarian investor? My value investing bias leads me to monitor fund managers like Maple Brown Abott or Investors Mutual or one of the other value investors. The important thing is to make sure their style matches your idea of what makes a good investment.

Benefits Of Following Fund Managers:

As I said earlier, these guys have more resources than you do. They're likely to have looked of lots of companies before buying and hopefully they've done their homework. And while this doesn't mean you should automatically follow them, it can give you ideas or add weight to an idea you already have.

Disadvantages Of Following Fund Managers:

I will stress again that you should not mindlessly follow the actions of one or more institutional investors, buying and selling whatever shares they do. You're not privy to the reasons behind a given transaction. Remember the decision was made in the context of an entire share portfolio. Depending on their investment strategy, it may be part of an broader asset allocation policy. Or it could be a high risk purchase of a distressed security in an industry where the manager has special expertise. Or any of more than a dozen other reasons.

The other problem is when they sell. They wont give you a call or send you an email to tell you they're about to sell. And if they're a big investor and they sell a large quantity of stock, the share price could be dragged right down by the selling pressure. You could then be stuck with an unloved company which was bought for reasons which may no longer be apparent.

If you take a long term approach to wealth creation you can afford to be patient. The Australian stock market will continue to throw up bargains so you can afford to be picky. Keeping an eye on the fund managers can be good sport but don't get carried away.