Retail investing is booming these days – armed with information availability and sharing, they are largely crushing vast majority of institutional investors in terms of performance. Having exposure on is ALSO A SKILL, so I would actually attribute significant retail outperformance to their skill that may not be about spreadsheet building, but getting the macro trend correctly. However, there are also key advantages that retails have that institutional investors do not have, and I wanted to discuss that here.
And as retail investor, you should always look for opportunities to find companies with below characteristics so that you can maximize your INTRINSIC EDGE (“MOAT”) over institutional investors who have systemic or political restraints.
Anyways, I wanted to use Virgin Galactic ($SPCE) and Tesla ($TSLA) as examples of stocks that retail investors have edge over institutional investors or institutional investors do not have an edge over retail.
LEADING COMPANIES IN MASSIVE SECULAR GROWTH INDUSTRY
Tesla/Virgin Galactic are in massive growing industries – electric vehicle/renewable energy and space/sub-orbital travel. They are very much forward-looking businesses and so much so that DCF or detailed financial modelling does not matter. Here institutional investors lose edge over retail investors. Many hedge fund analysts learn hard-cord financial modeling at investment banks, but these models are largely useless as the stock valuation is more driven by future value.
Highly detailed model will only lead to “false precision” – the 1000-line detailed spreadsheet is just as useless and useful as simple high level math of rough estimate of car delivery growth over the next five years. Only the market knows the true value.
These companies in sexy areas also tend to trade at rich multiples as market has high expectations of growth. Therefore, they are “overvalued” relative to the “valuation” from traditional DCF valuation and they are often used as “funding shorts” – companies that hedge funds short to hedge market risk out in their long position. This artificial downward pressure of stock keeps the future demand for the stock healthy – this becomes especially powerful if the company executes above expectations. Eventually, many of these companies grow into high multiples or “buy down their multiple” in hedge-fund speak.
STOCKS WITH HIGH VOLATILITY
This is somewhat related to politics and systemic structure of many funds. For many hedge funds, weekly or monthly performance is EXTREMELY important. It is increasingly becoming more important to keep portfolio volatility low because Sharpe ratio, which divides performance by volatility, is becoming increasingly important in performance evaluation of portfolio managers’ portfolio construction skills.
Therefore, many portfolio managers who could generate amazing excess returns with higher volatility (this includes many investing legends in the past) had to leave the industry, and industry is now filled with portfolio managers who are trying to make 5-10% consistently.
If you want to have a low volatility portfolio, you must fill your portfolio with low volatility stocks – some $500mm portfolio could have much more significant $ volatility depending on the sizing and selection of stocks in it. It could be a portfolio whose value is expected to fluctuate by $50mm or $100mm.
Therefore, junior analysts tend to pitch low volatility / safer ideas to portfolio managers, and they end up avoiding investing in stocks during its phase of high volatility (high growth mode). The company continues to execute on its plan with capital being deployed at high ROIC, but eventually it should enter low volatility period – this is when institutions jump in and this demand further pushes up stock price. What do you do here as a retail investor? You flip them over to them and move to the next idea.
STOCKS WITH HIGH RETAIL PARTICIPATION IN TRAFFIC/FLOW
One of key advantages that institutional investors have is getting more information around traffic / flow of stocks. In stocks where institutions are trafficking a lot, institutions have a better sense of the flow (“large long only in boston is unloading stock XYZ”) and they have a better view on the set-up into quarters (in terms of true investor expectations and potential move up or down) – hence they are more comfortable and willing to take more risk (easier to trade). However, in stocks with heavy retail traffic, institutional investors do not have a firm grasp on the trading dynamic of the stock and do not invest aggressively. Therefore, this leads to narrowing the edge between institutions and retail, and with less institutional participation, there is less demand for the stock and retail investors can get in at a lower valuation.
STOCK PRICE IS DRIVE BY DEMAND AT THE END OF THE DAY
Stock prices reflect supply and demand for the stocks that is partially based on fundamentals and partially based on trading dynamics. As retail investors, we should always strive to play in areas where we have all the advantage over institutions and try to avoid in stocks where institutions have clear edge. For instance, heavy credit-card driven retail stocks are prime example of stocks where institutions have CLEAR EDGE because they have credit card data and stock value is largely based on quarterly earnings.
This is why I remain focused on investing in strong platform companies when it comes to biotech investing – $SGEN, $GMAB, and $ALLO.
Investing is a process game – if you continuously improve the process to push your odds in your favor, I am sure it will lead to better and sustainable outcome.
Happy Investing!
*not investment advice
