Coattail caveats

30May07

Coattail investing according to Investopedia is “An investment strategy where investors mimic the trades of well-known and historically successful investors.” James Altucher at TheStreet.com has been writing a series of “trade like XYZ” articles for some time now. The most recent being on the hedge fund Atticus Capital.

We have previously posted on how the Internet has opened up the information floodgates making stock picking information now widely available. Sites like Stockpickr.com have already come a long way and are a great resource. However, they are a tool, and tools can be used to great effect or to make a mess.

The question is to what degree should the investments of others dictate your investment process? For quite some time one could go to a site like Morningstar.com and track down the top holdings of various mutual funds. The challenge of course is that this information is by definition stale, and may not be a good match for your investment process.

This notion of coattail investing becomes infinitely more difficult in the world of hedge funds. The challenges are at least two-fold. First hedge funds in all likelihood have a shorter time horizon than most mutual funds. Therefore by the time data is released publicly it may be stale, i.e. the hedge fund may have already exited said position.

Second since a great number of hedge funds hedge their positions you may not have the full investment picture. This is especially true in a world of options, and various OTC derivatives. For instance Felix Salmon at Market Movers highlights a fund that actually hedges its position to great effect. Justin Lahart at WSJ.com notes how some hedge funds are hedging their long stock positions with credit default swaps. That information is hidden to most observers and not easily replicable.

We should also note the area of disclosure is a contentious one at the moment. Jack Willoughby at Barrons.com notes how some investors have garnered exemptions, albeit temporary, from disclosure rules. Some think that the entire SEC disclosure regulatory regime needs to be overhauled. Hedge fund manager Phillip Goldstein is fighting the SEC in court to overturn current rules to allow investors, like himself, to keep their holdings private.

One way to finesse the inherent problems with disclosure is to follow investors with longer time horizons. Warren Buffett’s portfolio has been the fodder of intense scrutiny and speculation for quite some time now. Conrad De Aenlle in the New York Times looks at whether it is preferable to imitate Buffett’s trades or simply buy Berkshire Hathaway stock outright. Speaking of Berkshire, Jeffrey Ptak at Morningstar.com caught up with Lou Simpson to discuss investment philosophy. By following investors with a long time horizon one can avoid some of the inherent problems following a higher turnover strategy.

That is not to say that you shouldn’t look at what high profile investors are doing in their portfolios. Mebane Faber at World Beta has done some neat stuff generating “consensus” hedge fund portfolios. Also Justin Fuller at Morningstar.com has generated an “ultimate stock-picker’s portfolio” from the holdings of a select group of value mutual funds. These are good examples of how one might go about exploiting this information in your portfolio.

As we have written before – investing is hard. If it were easy, everyone would experience investment success. Coattail investing is a way of illuminating investment opportunities. However investors need to note the many challenges of the filings data, including time lags, incomplete information and strategy mismatches. Learning from the masters is indeed a good educational opportunity, but in the end great investors go out on their own and generate their own investment ideas.

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