The Investor's Advantage: David vs. Goliath

03/27/2015 9:00 am EST

Focus: STOCKS

Charles Mizrahi

Editor, Park Avenue Investment Club and Inevitable Wealth Portfolio

In the investing world today, institutional investors are the Goliaths. Does a knowledgeable investor, the modern day David, stand a chance to outperform these giants? asks Charles Mizrahi, editor of Hidden Values Alert.

Absolutely; in fact, most of the institutional investors’ strengths are actually their weaknesses and the knowledgeable investor has the advantage.

Institutional investing has evolved over the past 30 years in ways that have handicapped their performance. In most years, more than 90% of institutional investors underperform the S&P 500 index.

The goal for many firms is to retain what they have and gather more assets. If a firm slips up and has negative performance, there is a real fear of losing assets to another firm that is performing better.

The nature of the business has created an environment where institutional investors have to focus on short-term relative performance.

Instead of investing in what looks attractive on a valuation basis and holding for the long-term, they begin buying what other managers are buying so as not to fall behind in performance. That is why the average holding time for a stock—which was once measured in years—has now shrunk to months.

In addition, the measuring stick is not an absolute return but a relative return. For example, if fund A is down 20% and fund B is down 18%, the manager of fund B is having a happy day.

It reminds me of the old joke of two hikers who see an angry bear approaching, so one of the hikers starts putting on a pair of running shoes. The other one says, “You can’t outrun a bear!” So the first hiker answers, “I don’t have to outrun the bear, I only have to outrun you."

There are close to 5,000 listed companies on both the NYSE and NASDAQ, yet portfolio managers have to exclude the majority of them from their universe.

If a great company, outside the fund’s sector or geographical location, is trading at an extremely attractive price, the portfolio manager’s hands are tied.

And many stock funds are mandated to be fully invested at all times. If prices of companies within the portfolio manager’s universe are trading at sky-high valuations, the portfolio manager has no choice but to continue to plow their excess cash at even higher valuations.

Knowing what you are up against, do you now see how you have a big advantage? As a knowledgeable investor, you have none of these restrictions imposed on your selection of stocks to choose from.

You know that over the short-term, stock prices move based on fads and popularity, but over the long-term (three to five years), stock prices move based on the earnings of the company.

To you, it really makes no difference if the latest government report came in a tenth of a % higher or lower than expected. Over the long-term, it doesn’t mean a pile of beans. You use those opportunities to scoop up shares of great companies selling at fire sale prices.

The real success comes from investing in financially sound companies that are selling at attractive prices and holding them for the long-term.

For example, here are two new stock ideas that qualify as Prime Time Selections for our portfolio:

KKR & Co. (KKR) a leading global investment firm that manages investments across multiple asset classes including private equity, energy, infrastructure, real estate, credit, and hedge funds.

KKR manages $96 billion in assets across a variety of funds and. Alternative asset managers are gaining market share and KKR is gaining even larger share.

Capital Southwest Corporation (CSWC) seeks capital appreciation through long-term investments in privately held businesses. In June 2013, Joseph Armes was hired as CEO, and in December, management announced plans to separate the company into two publicly traded companies in order to unlock shareholder value.

Insiders have been aggressively buying shares in 2014. In my view, the stock is undervalued based on the pending spin-off transaction.

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