19 September 2019
Canadian author Malcolm Gladwell compares investing with the biblical story of David and Goliath. Not everything is what it seems. Photo: Bloomberg
Canadian author Malcolm Gladwell compares investing with the biblical story of David and Goliath. Not everything is what it seems. Photo: Bloomberg

Institutional vs retail investor: Spot the real winner

It’s a common belief that institutional investors have great advantages over retail investors but is it true?

Malcolm Gladwell, a Canadian journalist and author, discusses this subject in his book David and Goliath: Underdogs, Misfits, and the Art of Battling Giants (2013). 

Gladwell argues that most retail investors think institutional investors have more influence on stock prices and they also benefit from more comprehensive market research.

They’re able to talk to company executives to obtain first-hand information.

However, in reality, institutional investors don’t always have the upper hand over their retail counterparts.

Gladwell cites the biblical characters in comparing the two types of investor.

“As Goliath moved in for the kill, David slung a stone at Goliath’s head. It hit the giant’s forehead and he fell face down to the ground. David then took Goliath’s sword and stabbed him.”

Goliath was covered in armor to protect him and carried a big spear, which restricted his movement.

But David, with no armor and no big weapon, was more agile and nimble.

Similarly, funds sit on a pile of capital. It takes a few days, even a few months, to buy or sell them.

It takes a fund manager much more time to stop a losing bet than a retail investor.

On the other hand, if a retail investor wants to take profit, all he needs to do is click a button. A fund manager can only execute a sell order on a day-to-day basis.

Hong Kong Monetary Authority chief executive Norman Chan was questioned by legislators after the Exchange Fund underperformed the market several years ago.

There’s no easy way to compare an investment portfolio of several dozen million dollars with the likes of the Exchange Fund which holds trillions.

The bigger the fund, the more difficult it is to manage.

Many funds have specific house rules, one of which caps the weighting of a single stock in the portfolio, such as 5 or 10 percent.

These limits help mitigate risk but fund managers are forced to sell long-time winners if they keep outperforming.

It’s like cutting flowers while keeping the leaves green.

Frequent interactions with company management may not necessarily provide useful information.

Peter Lynch, who managed the Magellan Fund at Fidelity Investments from 1977 to 1990, averaged a 29.2 percent annual return, more than doubling the S&P 500 and making it the best performing mutual fund in the world.

But not all funds have had the same success. A lot of information does not necessarily lead to good investment decisions.

People have spent little time thinking about the different restrictions on giant institutional investors.

Also, they tend to miss the fact that retail investors have far fewer such constraints, making them more flexible.

For example, financial stocks account for 45 percent of the Hang Seng Index.

Fund managers are forced to buy financial plays even if they are out of favor for fear of lagging the benchmark.

By contrast, individual investors can ignore that and focus on what they like.

In his book Outliers: The Story of Success, Gladwell, points out the “10,000-hour rule”.

He says the key to achieving world-class expertise in any skill, is to a large extent a matter of practising the correct way for 10,000 hours.

There is no free lunch. Individual and institutional investors have to practice hard in order to succeed.

This article appeared in the Hong Kong Economic Journal on Oct. 30.

Translation by Julie Zhu with additional reporting

[Chinese version中文版]

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Columnist at the Hong Kong Economic Journal