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Copying A Fund Manager's Equity Portfolio Is Bad Idea

The fact of the matter is that most of us...
... do not have the expertise to research stocks
... do not have the time to monitor our investments
... do not have the right aptitude to handle market volatility
... do not have the inclination to work hard.

So, many of us simply choose the easiest option — copy the best mutual fund managers (or other successful investors like Mr. Rakesh Jhunjhunwala).

We buy what they buy — and hope to make tons of money like them. In financial jargon this is known as 'mirror investing'.

Beware! This copycat approach has some (very) serious drawbacks.

1. Both have different objectives
The objective of fund managers is to beat the benchmark and MAXIMIZE PROFITS. They have to create 'alpha'.

Naturally. Why would anyone invest in a mutual fund that delivers poor returns vis-a-vis its peers? In other words, the fund managers aim to be the "best" investors in town.

Any, why do we invest our money?

Of course, to MEET OUR FINANCIAL GOALS. We don't have to necessarily be the "best" investor. We are NOT competing with anyone else.

As long as we achieve our aims (be it children's education, house, marriage, retirement, vacations, gadgets, etc.), it does not matter if we do not buy the best companies and make the best returns. It does not matter if we don't buy at the lows and sell at the peaks.

Our focus is to invest in decent enough companies, to make decent enough money and fulfill our decent enough needs and desires.

Given this difference in objectives, it is but natural that our choice of stocks cannot be the same.

copy-best-fund-manager
Watch Out! You can copy all you want, you’ll always be one step behind.

2. It's not possible to make an exact copy of the portfolio
A typical mutual fund portfolio will have 30-50 stocks (maybe even more if the corpus is big).

Whereas your corpus is limited. So you cannot buy ALL the stocks that feature in a particular MF portfolio. In short, you have pick and choose among these 30-50 stocks. (Even if you manage to buy all the 30-50 shares, you are building up huge transactions costs, which will eat into the returns.)

Now, the question is which stocks will you choose? You don't know at what price the fund manager bought the stocks. You don't know how long the fund manager intends to hold the stocks. You don't know at what price the fund manager will exit.

Merely knowing the names of the fund manager's "preferred" stocks is not enough.

And, since your portfolio will be a small sub-set of the main portfolio, it would be less diversified. Consequently, it would be prone to higher risk.

3. The liquidity requirements don't match
There are two issues here.

First, the fund managers have to keep a certain amount of corpus in cash, to meet the day-to-day redemption. You, on the other hand, don't have any such commitments.

Second, given the large portfolio, fund managers are well-prepared to handle large and sudden redemption requests. Your "smaller" portfolio will surely be tested if you have to withdraw large sums at short notice.

If you try to focus on liquidity, your returns may suffer. If you chase returns, liquidity is at risk.

So what stocks are good for them, may not be good for you too!

4. Other limitations in trying to mimic a fund manager
That apart, on many other parameters too, it would be dangerous to copy a fund manager's selection of shares.

a. Fund managers can afford to take higher risk with some shares. Their portfolio is adequately diversified to take care of losses, if any. However, such stocks will increase the risk of your limited portfolio.

b. There is information asymmetry. Fund managers have access to the company's management team. You don't. So, they are aware of the company's plans much before you come to know about them.

c. Fund managers have a strategy behind the weightages they assign to each stock and sector. You are not aware of this. So you could end up being over or under-exposed to a particular stock or sector... which means either higher risk or lower returns.

d. Fund managers have a clear strategy of when to enter (or exit). You don't. So by the time you become aware that the fund manager has bought (or sold) a particular stock, it may be too late. This time lag can have serious consequences.

e. Your brokerage costs and taxes would be much higher than those of the mutual funds. This would easily eat away the 2-3% annual fund management expenses, which you are trying to save by directly investing in stocks.

Concluding: Given the above challenges, it would be foolish to try and copy the fund managers. Most investors would be much better off investing in the mutual funds itself, rather than trying to mimic them.

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