Coattail investing is an investment strategy (or rather lack of strategy) of mimicking the trades of well-known and historically successful investors. By placing these trades, investors “ride the coattails” of respected investors in hopes of creating money in their own accounts. Today, through public filings, media coverage and reports written by fund managers, the average investor can quickly learn where these big investors are placing their money. The art of mimicking high-profile investors isn’t as simple as it appears because of the various factors that come into play within the lifetime of that investment. This is one of the biggest problems of aping a smarter investor.
Few are aware of how long the capitalist intends to stay with the stock. During this time, the excitement about the stock, which keeps the demand elevated, helps the original investor make a smooth exit. The problem here is once the dominant capitalist gets out, these stocks turn illiquid, and the copycat investors are left holding duds. Those who attempt to copy the portfolios of shrewd investors also end up getting disappointed. This is the reason it is impossible for piggy backers to imitate these strategies.
Copycat investing has its risks. If not implemented well, the risks outweigh the benefits. Keeping aside the timing risk described above, an investor may pick the wrong coattail to ride. Many successful investors acclaim within the press of how his or her investment savvy and former winning trades will, and often have, demonstrated consistently profitable investments.
In fact, popular investors are humans too and they err. Investors riding their coattails on a number of these unprofitable trades have learned new meanings of regret.
How are these investors/investments tracked?
- All listed companies need to disclose the names of investors who hold more than 1% of the stake in the company. This can be a source to find big investors who are getting into which company.
- Stock exchanges publish block or bulk details data on a daily basis. This is also a source to find out who is buying what.
- Another source can be a monthly portfolio disclosure of mutual funds. If a good mutual fund is initiating or building up a position in a stock, the monthly disclosure will tell that very clearly.
Differentiated access to information
Individuals & institutions parking huge amounts of money have direct access to the management and can engage with them at levels and frequencies that an average investor may or may not have. Whether the information discussed in those hush-hush meeting is insider information or not, is a separate discussion, however there are so many things about a business that an annual report or research report does not speak of. An interaction with ‘people’ opens up insights into the actual direction of the business. So, the purchase & exit of these investors is also determined by this X – factor, which may be unavailable or incomprehensible to the average retail investor, thus making ‘coat-tailing’ slightly more profitable or slightly more riskier depending on one’s luck and timing.
This is a trend that has been catching up in the recent times. Global business behemoths that have become ‘lazy’ and ‘less innovative’ are being pulled out of their slumber by aggressive outsiders with outrageous amounts of money. So, when your favourite investor is actually getting into the stock, he/she may be getting into it not because of their liking towards it, but to actually bring about change in its business itself. Historically, activist efforts in organizations have brought out mixed results. So, the retail investors must also hold caution to understand ‘why’ the investor bought it in the first place to ascertain his own decision.
Generating alpha (or outperformance) from stocks requires proper research, skill and adequate allocation. And this has been the secret of successful investing for decades. Copycat investors never make big money. They just react to various news items and never have any idea about the complete picture. While it does look good on paper or theory to try and mimic the investment picks of successful investors, it is often much harder if not impossible to do so in practice.
It is always better to seek help from competent investment advisors with well-defined research strategies to seek growth & profitability in stocks.
Disclosure: This article is inclined towards documenting the perils of coat-tail investing given that we firmly admonish the idea of coat-tailing and urge our readers against using this strategy. 😊