How a cat beat professionals at stockpicking

A teachable moment.

New Statesman

The Observer spent 2012 challenging a panel of professional stockpickers – a wealth manager, stockbroker and fund manager – to beat schoolchildren and a cat at making a profit from the stock market. The cat won:

Each team invested a notional £5,000 in five companies from the FTSE All-Share index at the start of the year. After every three months, they could exchange any stocks, replacing them with others from the index.

By the end of September the professionals had generated £497 of profit compared with £292 managed by Orlando. But an unexpected turnaround in the final quarter has resulted in the cat's portfolio increasing by an average of 4.2% to end the year at £5,542.60, compared with the professionals' £5,176.60.

Click through for some awful puns.

Naturally, this is a teachable moment. Matt Yglesias points out that, even if the cat had lost, once fees are factored in it would almost certainly have beaten the professionals. The traditional "2 and 20" fee of hedge fund managers – that's two per cent of the investment and 20 per cent of the profit – is easily enough to turn a market-beating fund into a market-losing investment.

But the cat may have been aided by the year in which the competition took place. Zero Hedge reports that, over 2012, the S&P rose 16 per cent, meaning that:

A whopping 88% of hedge funds, as well as some 65% of large-cap core, 80% of large cap value, and 67% of small-cap mutual funds underperformed the market.

Barron's explains why a strong index is bad for hedgies:

Hedge funds typically lag behind broader indexes slightly during years with double-digit S&P gains—they do have to hedge, after all—but it's rarely by this much.

Managers across all strategies are concerned about another 2008-like market crash, but in the meantime, they've been hurt by central banks' persistence at keeping interest rates low. Add in volatility and a U.S. presidential election where the top three issues are the economy, the economy, and the economy, and it's clear that hedge-fund managers are more concerned about managing risk than gambling on equities. Investors and other industry observers say that for perhaps the first time since the phrase hedge fund entered the lexicon, hot or gimmicky strategies aren't worth investing in at all. It's the manager that counts.

The cat was picking from the FTSE rather than S&P, but much the same lessons apply. Markets have performed well this year; gimmicky stockpicking strategies haven't; and, of course, there was a healthy dose of feline luck.

But maybe hedge funds and stockpicking are always over-valued? Warren Buffett thinks so; he made a $1m bet in 2007 that:

Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.

That's critical of funds-of-funds – which add another layer of returns-destroying fees – but it's representative of a growing trend. If you must invest in something more complicated than an all-shares index, try a dart-board and a list of stocks.