Investing For Fun & Profit

20th September 2008

Phil Wall tells a cautionary tale.

Some see the stock market as a sure-fire route to profit, and it’s true that over the long term you have to be unlucky not to make money on the stockmarket… although there are, of course, those occasional catastrophic drops that can wipe some investors out completely.

I’ve not had that experience, but I can’t claim great success either. For example, back in 2000 I had £3,000 to invest. I wanted long-term growth with some acceptable risk and no hassle – no daily market study to check the diversification of my portfolio; I didn’t even want the job of working out a portfolio to begin with! Luckily there are plenty of people who do that for a living, so I handed my £3,000 over to a fund management company. I chose a ‘European smaller companies’ fund, which was doing well and apparently had ‘potential for further excellent growth’. More risky than the blue chip FTSE 100 crowd, but more exciting and perhaps far more profitable. I won’t name the fund management company, for reasons that will become obvious, but it sounds quite like Fiasco, so I’ll call them that.

Fiasco happily took my meagre savings, but, as they were legally obliged to give me a cooling-off period they wrote to check if I really did want them to handle my money. All their projections showed the value increasing and they boldly claimed to be aiming for ‘above average capital growth’. What's not to like?

So away we went. They pointed out that I could check the fund’s progress daily in any quality newspaper, but, frankly, life is too short. There’s a saying that life is like a taxi: the meter's running whether you're going anywhere or not. Daily perusal of the financial pages is my equivalent of sitting in that taxi at 5pm on a Friday somewhere around M25 Junction 17.

Thus I lived in blissful ignorance of the fund’s performance until April 2001, when a statement arrived. Surprise! My hard earned £3,000 had become £1,671. I tried to remain philosophical. It wasn't the end of the world, nor even of my life savings, and in time things would undoubtedly pick up. I did recall that letter they sent in the cooling-off period though… I was now feeling extremely cool towards investment companies in general and Fiasco in particular.

By the time of the next statement, in October 2001, my investment was worth £1,189. Fiasco had lost almost two thirds of my money in sixteen months. I could have done that myself in Las Vegas, with a holiday thrown in. A professional investment company who had boasted that they controlled over £11 billion (probably half that by this time, actually) and they'd done this! Well, it was expendable money – to a point – but I wasn't taking that lying down. So I sat down, partly in astonishment, and partly to write to Fiasco’s ‘Customer Communications Manager’: What was going on? Weren't they supposed to be good at this? How were they picking stocks? Should I have thrown darts at the paper to select my investments instead? Who was running this fund, and what qualifications did they have?

Picking stocks is something that professionals like to endow with mystique, because the more complicated it looks the more likely it is people will pay them for it. Of course it is tricky, because they’re trying to predict the future. There are many systems, but you can boil them down to just two basic methods: fundamental analysis and technical analysis. The former looks at the fundamentals of a company: accounts, ratios, dividend earnings and so on, working out whether a company is fairly valued by the market. The latter is interested in market trends and patterns found in graphs, believing that the past ups and downs will reveal the future.

I was interested to know Fiasco’s preferred method, partly so I could be sure to avoid it in future. I never found out, although I did receive a very polite letter (they could afford to be polite; it wasn't their money) from Customer Communications. They cited the effect of the 9/11 attacks (okay, but the value had already halved before that) and the technology stocks slump when the first internet boom ended. They admitted that the fund manager had been slow to realise gains from the boom (which I invested too late to see) and in hindsight should have diversified further. The fund manager, they said, had a Cambridge degree. In classics. Which doesn’t actually seem much of a qualification for the job. They wouldn’t tell me whether she was being made to suffer financially, like her clients, by being paid only a third of the sum she expected.

£1,189 was the low point. My investment’s value then hovered between £1,200 and £1,350 until 2003, when the classically trained fund manager was replaced. The new incumbent lasted six months before being succeeded by a chap called Adrian, whose name was amusingly spelled ‘Adrain’ in the fund’s newsletter. It would be ironic if he had been the one who was ‘a drain’ on my funds, but in fact he has overseen something of a recovery. Whether he’s actaully any good or the market has just picked up is a matter for debate.

The real question is, are any fund managers any good, or are some just lucky? Suppose there are 1,000 fund managers and the market goes up five per cent in a year. By sheer luck, half of fund managers do better than that and half worse. Next year the market goes up again, and of the 500 who were lucky in year one, 250 do better than the market again. Same growth in year three, and by luck again half of last year’s ‘winners’, now numbering 125, still beat the market. (Some others, with previously below average results, will do well in year three too, because at any time half are ‘good’ and half ‘poor’, but let’s concentrate on the consistent ‘good performers’.) In year four the market stagnates, but half of last year’s ‘good’ fund managers are lucky again, and provide positive returns. We’re down to 62, who have had four good years in a row. It’s just by luck… but people look at them and say “These guys really know their stuff! They were great in the good years and even in a stagnant market they still made a profit!”

Perhaps you’re thinking, ‘This can’t be how it really works, because what about the four-time losers?’ Well, they lose their jobs, and are replaced by a new bunch, some of whom get lucky for a while. I’m quite prepared to believe this hypothesis, but the human turnover prevents it being conclusively proven.

So whether young Adrian really knows more than his predecessors or is just luckier, I don’t know. Either way between 2003 and 2008 my fund’s value climbed steadily back towards where it started. It even reached £3,327 in August 2007. But my latest statement shows £3,001 and I’ve decided it’s time to quit. I can escape with my original sum intact, which is a result of sorts, although a savings account at four per cent compound interest would have given me £4,105 by now.

I was unlucky to invest at the end of a boom, but Fiasco didn’t say that they thought the good times were coming to an end – quite the opposite in fact. I’m fortunate to have my money back, but I must remember now that trying to predict the future is a lottery. In gambling, the bookies always win. In stocks and shares the equivalent guaranteed winners are brokers and investment funds – but they’re never confident enough to adopt a ‘no profit, no fee’ policy. Perhaps that tells you all you need to know…

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