Does 'copying' a portfolio work?

Copying a portfolio

Some investors are architects of their own portfolios while the rest prefer to the mimic the portfolios of successful investors. But riding on the copycat bandwagon can be dangerous, particularly if you are tailing an institutional investor's portfolio. Although the strategy is not without any accomplishments, the evidence about its success is quite diverse.A research paper from Cambridge University states that after about four years of copycatting, the performance of the copycat funds decline by an average of 3.2 per cent. The fact that you are one step behind, by clinching to the back of other investors places you at a huge disadvantage. Consider investing as game, you cannot win unless you come up with your own idea at some point during the play.

Let me explain you why copycatting portfolio is not a good idea:

Incapability to diversify sufficiently:

Institutional investors are able to diversify their holdings over a number of companies so that even if one sector or industry or country dips, the other holdings will pick up the droop.

But individual investors do not that much funds or financial ability to attain such diversification. So they try to copy just a small portion of the original holdings by investing heavily in some holdings while ignoring the rest. And this is where the trouble kicks in – esp. if one or more of these holdings decline suddenly.

Fractional differences:

Let's say that you are copying an investor who has about 50 stocks in his portfolio. Some of his investments occupy only 0.2% of the total fund value. Now, you are investing around ₹ 1,00,000. As you invest in the same stocks as the primary investor, you allocate 0.2% of your capital to the minor investments. This is about ₹200. But ₹200 is not sufficient to buy that stock. So you end up investing more than 0.2% of your capital in an attempt to copy precisely. But the deviation from the original weight of the fund holdings will affect the overall performance. The issue is that, a common man can't imitate the fractional shares accurately.

This uneven imitation is the major reason why may individuals fail to outperform even when they maintain similar holdings of an institutional investor.

Variable investment horizons:

The impatience of an individual investor ends up adversely affecting their fund performance, even if they were able to achieve the same diversification they are replicating. They are usually not able to afford to sit patiently for 5 to 10 years as the institutions do as they have to tap the investments to meet their expenses.

Institutional knowledge:

Investing institutions often employ industry experts who have extensive networks and are well informed about the company's management or industry. They have an upper hand in being informed about the current status, upcoming policies etc. which helps them to decide about future earnings, growth or opportunities. It is almost impossible for a common man to gain such knowledge and this affects the fund results. Majority of times, individuals underperform an investment due to lack of relative knowledge.

Difficult to follow up:

The lack of institutional knowledge is multiplied by the fact that the experts can sit and wait for information while an average person has to attend other works. This causes a time lag and can prevent the investors from getting grabbing an opportunity or exiting at the best moment.

Many mutual funds buy and sell with great intensity every quarter and it is difficult to keep tabs on the actions of the institution and copy them precisely. A regular person with a job does not have enough flexibility to involve actively like a big player who is mostly a full time investor or manager. And if you miss out an action, you are left guessing. This is a huge risk in a volatile market.


Information holdups:

Mutual funds are required to publish their holdings only on a half-yearly basis. So they are wary about not letting the market know the changes made in their holdings. Hence, there is a possibility for you to be left lagging for up to 6 months and there is no way for you to overcome this delay.

Exit strategy:

Maybe the ace investor whom you copy has invested in a mutual fund scheme with a plan to exit after earning 60% of the profit as they do not believe that the fund would be successful in a long term. But a copycat individual will not be aware of this and would end up planning for a long term stay in the same fund.

It is easy to copy the portfolio of successful investors. But how will you know or understand their exit strategy?

Conclusion:

The bottom-line is that, "copying" a portfolio is not a really good idea. Yes, it works, but more negatively than positive. Each person has a unique financial situation, limitations and risk appetite. It is safer for you to create your own portfolio based on your means and diligence for maximum success. 

 

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Mutual fund investments are subject to market risks. Please read the scheme information and other related documents carefully before investing. Past performance is not indicative of future returns. Please consider your specific investment requirements before choosing a fund, or designing a portfolio that suits your needs.