It is often said that the financial market is like a battlefield between David and Goliath, it is a war between the small-time retail investors (the “dumb money”) and the mighty institutional investors (the “smart money”).

The retail investors did lose money most of the time because unlike David, they underestimate their opponents. Thanks to the popularity and success of passive investing, retail investors are often misled into believing that a fund manager’s stock-picking skills are worse than a chimpanzee throwing random darts at a stock chart.

But if you think about it rationally, do you really think the people working in Wall Street, who have gone through rigorous financial training, survived decades of bull and bear markets, and spent their entire career trying to make money in the stock market, don’t know what they are doing?

In the course of my career as an independent financial adviser, I have spent more than a decade juggling between institutional fund managers and retail investors and I have a good understanding of both sides. Many things have happened and the landscape of the battlefield between the institutional investors and retails investors has changed a lot.

But one thing is for sure, the smart money operated by the institutional investors still amass massive information and resources which give them an edge over the retail investors. And here are the top 5 secrets that they don’t want you to know.

#1. The pool of victims

If you have been investing in stocks for years and you are still losing money, it is most probably because you started off on the wrong foot. You probably took what people told you at face value without verifying the source or using your own independent assessment.

The financial world is full of contradictory misinformation. On the one hand, you hear people saying that “fund managers always underperform the market”. On the other hand, you may notice that professional investors pay a lot of attention to the fund managers’ allocation. Many books and quite a few financial bloggers claim that you can do better through buying and holding a low-cost ETF and therefore you can outperform a fund manager. Well, this is a myth.

You may not even realize that most of the financial information that you consume and believe are in fact manipulated to fit a certain agenda to create a pool of “financial victims”.

When it comes to investing, many people like to quote Warren Buffett. There are tons of books and investing courses trying to borrow Warren Buffett’s fame. But as far as I know, Warren Buffett never wrote a book about his own investment strategy, nor did he conduct any value investing courses. The so-called “Warren Buffett’s Way” is merely what people derived from what they heard during Berkshire’s AGMs and what they want to believe.

What I am going to say may offend a lot of Warren Buffett’s fans, but Warren Buffett does not walk his talk.

  • Warren Buffett said that he cannot correctly place a value on technology companies; but, Apple is one of his biggest shareholdings.
  • Warren Buffett said banks are too complicated and too dangerous; yet, he is a large shareholder of Well Fargo, Bank of America and Bank of New York.
  • Warren Buffett called derivatives the “financial weapons of mass destruction”; but, his company traded a huge amount of options to buy shares at cheap prices.
  • Warren Buffett said you are better off with 90% of your investments in S&P 500 index ETFs and 10% in US treasury ETFs; but, he has never done so himself.

We all know that Warren Buffett is holding a lot of cash now. If he is so convinced that the S&P 500 is going to do better for the next decade, why didn’t he invest in it in March?

Yes, Warren Buffett is one of the greatest stock investors on earth. But what you have learned from the value investing courses or books may not be the same as what makes him a billionaire.

Very often, people say certain things but they do the complete opposite because that is how they make money. Sometimes when institutions want to dump certain shares, they will release very positive views or even publicly announce that they are buying the shares. Yet, the real intention was to sell them in the hype.

Sometimes, the big influencers talk down certain shares or industries while secretly building their buying positions.

When someone makes money in stock investing, someone else has to lose. Institutions rely on the less informed pool of victims to profit in the long run.

#2. Institutional funds are stealthy

The reason I talk about Warren Buffett is that he represents the “smart money” or the “institutional funds”. Unlike retail investors who like to boost their wins in blogs and online forums, institutions prefer to make money under the radar.

You may eventually find out how they make money, but it is unlikely that you can duplicate the process they use because the timing, market price and many other factors have changed. Just Google how Warren Buffett cut a deal with Goldman Sachs in the midst of the global financial crisis and you will start to doubt the “Warren Buffett Way”.

I often come across investors who refuse to put their money into funds and insist on buying stocks themselves. Unless you take stock trading as a professional career, it is naive to assume that a team of the smartest people on earth who have gone to the most prestigious universities, have taken 4 years of financial degree and have spent 10 years in the capital market, cannot do better than you.

Institutional investors have their own challenges which I will discuss later. But the truth is that institutional investors often make more money than retail investors in the long run. Some years back, trader Alessio Rastani made his fame by telling the world through his BBC interview, “Goldman Sachs rules the world!”. He was blunt but he revealed the truth that financial insiders don’t want to talk about.

During the oil crisis mayhem in April 2020, I wrote that it looked like it was a well-planned financial attack to slaughter retail investors. One month later, it was reported that Goldman Sachs commodity traders reaped $1 billion in commodity trading revenue. Is that a coincidence?

As the article mentions,

Dewell (Goldman Sachs’ trader), ran trades that correctly anticipated a collapse in the West Texas Intermediate futures market in April as storage tanks filled and prices spiraled toward zero. That move prompted a wave of forced selling from investor products such as exchange-traded funds that weren’t designed with the possibility of negative prices in mind.

We need to recognize the fact that when money managers bet millions if not billions on an investment idea, they are not just throwing random darts.

#3. Why the funds you bought are lousy

Now you may wonder, “Do fund managers underperform, or do they outperform the market in the long run?” The answer is, it doesn’t matter!

For many years, Ribena has been sold as a healthy drink based on advertisements that black currant juice has more vitamin C than orange juice. However, two science students found Ribena contained no detectable vitamin C, and shortly afterward the multinational company was fined.

People often believe what they hear without verifying the claims. For the hardcore believers in passive investing, you may pull out data showing how funds underperformed the S&P 500 over 10, 20, or 30 years and try to prove that mutual funds (as we call unit trusts in Singapore) are lousy.

If you torture the data enough, they will tell you what you want to hear. – Ivan Guan

Like many other industries, at least 80% of the products are lousy. But does it matter to you?

Let’s think about your favourite food. For example, if you are a fan of Punggol Nasi Lemak, does it matter that there are another 5,000 mediocre Nasi Lemak stalls? If you are a lover of Starbucks, does it matter that there are 50,000 other coffee stalls selling Kopi C?

The fact is, in any industry, there are good products and lousy products. Good products are always scarce, and it is up to you to find them.

Rejecting active funds in your portfolio is like saying that just because 80% of the coffee sold in Singapore is average, you should not drink coffee. – Ivan Guan

#4. Funds are created to sell, not to perform

To be fair to the people who pointed out many shabby practices in the financial industry, the fund industry has a lot to improve.

The financial industry is here to make a profit for its shareholders, and that includes the ETF providers. It is much easier to create a product to sell than to perform well.

  • If you like low costs, they create ETFs for you;
  • If you like prestige, they create a fund of hedge funds for you;
  • If you think 5G is the next future, they will make a 5G fund for you;
  • If you think a computer can invest better than humans, they give the Robo-advisers to you.

At the end of the day, you get what you ask for, even if you don’t know what you are getting into.

There is also a huge misalignment between the fund manager’s interest and investors’ interests.

Very often, we see the same fund manager “incubate” hundreds of funds across different sectors, countries, and strategies. By sheer randomness, some of the funds will perform very well. Then the fund manager will aggressively market the funds to unaware retail investors who mistake the outperformance as the fund managers’ skills.

It takes years of knowledge and experiences and a sharp eye to spot such tactics. That is why I encourage new investors to find a good independent adviser to help you get started. A well trained financial adviser may not give you the best returns, but most of the time they can help you avoid silly mistakes.

Additional Reading: How to dig below the sales pitch and choose the right unit trust.

#5. Institutional investors don’t always win

I said earlier that although institutional investors do have an edge over the retail investors given the information and resources that they amass, they have their own problems. One of the biggest issues is its size.

While you and I can enter and exit the market with a click of a button, institutions often take months to build up a position and they have to obey many rules that we don’t have to consider.

If you and a fund manager both identify the same investment opportunity and make 20% profit from a stock, it may add a lot of wealth to you but it has little impact on the entire fund the institution manages.

I will talk about this in more detail in the future but the gist is that retail investors are always more nimble than institutional investors.

When the US stock market went up recently, the news was full of reports that it was the Robinhood investors, the “dumb money” that was chasing the returns.

When the China stock market went up, news outlets started to comment that it was the mom-and-pop investors, commonly known as chives (韭菜, jiǔcài) in Chinese, who were chasing the market.

Believe it or not, retail investors can drive the market until the institutional investors go nuts.

Let me tell you a story. In early 2019, I attended a fund manager’s briefing. At that time, the global stock market was recovering rapidly from the low in 2018. The fund manager’s emerging market fund was underperforming its peers. The reason? The manager was underweighting China tech companies like Tencent which had a stellar 50% return over 3 months. The manager believed that it was “overvalued” and refused to go in. However, the investors of the fund were not happy and the fund manager was under enormous pressure. In the end, the fund manager gave in and agreed to add to the position, maybe because she finally saw some value in Tencent, or because she was afraid to lose her rice bowl.

And guess what, Tencent lost 20% in a month after the fund bought the shares!

Of course, I did not recommend the fund to my clients at all because experience told me that a fund that is influenced by their own clients will find it hard to perform in the long run. That is another day’s topic.

In short, there is a huge knowledge gap between professional investors and retail investors. Sometimes I have to give “unpopular advice” which really benefits my clients, but the clients just cannot see the benefits at those particular moments.

People like to hear what they want to hear, but it is often not to the best of their own interests. – Ivan Guan

There is an interesting phenomenon nowadays. With the proliferation of ETF investing, trillions of dollars are pouring into ETF funds and indirectly, retail investors have created their own “institutions”. It may mean the pool of victims become smaller.

You can think about the traditional institution as the fisherman and retail investors as the fish. When the fisherman casts his nets sometimes he catches a whole school of fish. More often than not, the fish panic and swim in different directions trying to escape. The fisherman wins!

But what if the fish are united and choose to swim in one direction? They may pull the fish boat a different way.

Maybe the recent sharp stock market rally was initiated by the “dumb money”. But once the trend is formed, the institutions, who were still sitting on the sidelines observing, may be “forced” to enter the market. Then they become the “dumber money”, for the same reason that I just mentioned.

As a result, the stock market rally may become a self-fulfilling trend.

Let me summarize…

To survive in stock investing, understanding the fundamentals of a company is just the beginning. The real money is made through understanding human psychology and social behaviours.

That is why institutional investors not only hire stock analysts and economists, they also hire psychologists and mathematicians.

I hope this article opens your mind to the idea that investing in stocks is much more complicated than you think. We need to admit that making money is never simple no matter how you do it. If someone tells you that you can learn stock investing by reading a book or attending an online course, they either have no idea what they are talking about or they are just lying to you.

But the good news is that we as retail investors have powerful tools nowadays, thanks to technological advancement. The information and tools that we have in a tiny phone for free used to cost the institutional investors millions of dollars.

What if we retail investors, instead of being a pool of victims, spend our efforts to analyze the psychology and behaviours of the institutional investors. Would that give us a better edge? That is why I am a strong believer in identifying market trends and following the fund flows.

The stock market is by and large a section of the financial casino. Besides you and me who are small-time retail investors, there are countless other players in the room: dealers, hedgers, arbitrageurs, traders, buy-side institutional investors, sell-side brokers, etc. Each player has their own agendas, preferences, risk appetites, and resources. Trust no one but yourself!

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About the Author

Ivan Guan is the author of the popular book "FIRE Your Retirement". He is an independent financial adviser with more than a decade of knowledge and experience in providing financial advisory services to both individuals and businesses. He specializes in investment planning and portfolio management for early retirement. His blog provides practical financial tips, strategies and resources to help people achieve financial freedom. Follow his Telegram Channel to join the FIRE community.
The views and opinions expressed in this article are those of the author. This does not reflect the official position of any agency, organization, employer or company. Refer to full disclaimers here.

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