Saturday, June 28, 2008

Copy-cat Investing

Most people take comfort in buying stocks that others have. After all, if other people think a stock is good, there must be something there, right? So it should come at no surprise that people love to know what star investors are buying. Not only do they like to know, but it makes them want to buy. For example, shares of CarMax rose 7.5% on the day it was released that Berkshire-Hathaway was buying in.

To fill this investor need for knowing what other investors are buying, a plethora of websites exist that track what large funds are buying. Can these be useful in guiding your own portfolio decisions? Unfortunately, a number of challenges exist which make it difficult to gain from this knowledge.

Investment companies only have to disclose their transactions at the end of each quarter. As a result, if you base your decisions on what these fund managers do, you could be trading on old news. Under certain circumstances, the SEC will grant funds the right to delay disclosing their purchases, which makes copying these funds' investments even harder.

There is also the case of mistaken identity. Just because a particular company bought a stock, does not mean the manager you were interested in did. Warren Buffett has griped about this issue in the past:

"The media continue to report that "Buffett buys" this or that stock. Statements like these are almost always based on filings Berkshire makes with the SEC and are therefore wrong. As I’ve said before, the stories should say "Berkshire buys."...Even then, it is typically not I who make the buying decisions. Lou Simpson manages about $2½ billion of equities that are held by GEICO, and it is his transactions that Berkshire is usually reporting."

Stocks the market bought after an erroneous "Buffett buys..." have subsequently fallen back to their previous levels once the market realized its error.

Blindly following the reported investments of fund managers can be detrimental to your portfolio. Nothing beats buying a company for its fundamentals, rather than because others are buying.

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