What individual investors can learn from the old guys

In early December, I attended an investment conference for institutional and high- net-worth investors. The speakers, with a couple of exceptions, were old guys responsible for the management of billions of dollars of investable assets ranging from real estate to listed common stocks to "distressed" income securities. As an old guy and retired chief investment officer myself, I didn't expect to learn much of value at the conference and that proved to be correct.

On thinking about it later, I realize that new arrivals on the scene of any ongoing activity, whether it is a sport or a business event, often struggle to understand the rules of the game which are second nature to long-time players. So, here are my observations from a couple of presentations. An experienced investor will find them self-evident, but they are useful takeaways for retail investors new to the investment process.

The first speaker was an 80-year-old Harvard MBA graduate who entered the investment business in the 1960s. At that time there were no Bloomberg machines and CFA (Chartered Financial Analyst) charterholders were thin on the ground. About 10 per cent of trades were initiated by professional investors who typically bought and sold blue-chip stocks for bank trust departments. The remaining 90 per cent of trades were the domain of amateur investors who had no access to brokerage reports or company management.

In this environment, it wasn't difficult to imagine that professional money managers could outperform a market made up primarily of amateurs. In his words, "It was like taking candy from a baby."

The world is very different now. When you place an order today, the odds are over 90 per cent that the other side of the trade will be filled by some type of professional investor with access to databases and analysis that you can only dream of. There are now over 300,000 Bloomberg machines (which give immediate access to sophisticated market data) scattered across the world, more than 130,000 CFA charterholders and another 170,000 enrolled in the program. Why on earth do you think that you can win at this game?

Needless to say, this speaker was an enthusiast of low-cost index funds. In fact, he suggested that instead of having to justify why you are invested in an index fund, we should turn the question around and ask the following: "Would you rather invest in this fund which is guaranteed to track the index of your choice minus a management fee of about 10 basis points, or this actively managed fund which has a fee of about 2 per cent and a 90 per cent chance of trailing the index over the next 10 years?" Would any rational person ever sign up for the second product?

The message from this speaker is loud and clear: Even if you bring tremendous resources to the market today, your odds of extracting value after management fees are extremely slim, so the amateur investor should focus on asset allocation and execute the strategy with index funds.

There might be an exception to this acceptance of market efficiency if your portfolio strategy involves an exclusive focus on under-researched and illiquid parts of the market. My investments in Canadian "busted" convertible bonds fall into this category, so I was hoping for some insights from the expert on distressed fixed-income securities.

His big-picture thesis was that the best time to buy distressed assets is when holders are forced to sell, not when they are choosing to sell. Currently, the extended period of very low interest rates in North America means that even terrible businesses have been kept alive and so there are no forced sellers. As a result, the yield pickup for taking on additional risk is inadequate. For example, the extra yield on sovereign debt issued by South Korea is 10 basis points over U.S. Treasuries. We all hope that the confrontation with North Korea will not lead to armed conflict in the area, but the possibility is not zero and 10 basis points is not a generous reward for taking on that risk.

This speaker has redeployed his portfolio to Europe where the central banks are pressuring their local banks to reduce balance sheet leverage. As a consequence, local small businesses are being turned away by the banks and forced into the shadow banking sector where his portfolio was extracting much higher rates. This isn't a strategy available to the individual investor, so the takeaway from this speaker is simple: Stick with high quality fixed income in North America – the reward for taking on additional risk is currently inadequate.

Robert Tattersall, CFA, is co-founder of the Saxon family of mutual funds and the retired chief investment officer of Mackenzie Investments.