Investing is one of those rare pursuits where amateurs can have an advantage over the professionals – writes The Undercover Fund Manager


It happens in almost no other field. If I competed against any professional sports person, I’d lose every time. If I was asked to perform dentistry or heart surgery, I wouldn’t know where to start. I don’t have the years of training needed to perform these highly specialised tasks.

However, good private investors, who know what they’re doing, outperform the pros on a regular basis.

I have personal experience of this – the amateur version of myself is outperforming the professional version! The share selections for my personal portfolio, on average, are outperforming the fund I run, despite my personal portfolio receiving far less attention (for the avoidance of doubt, my fund has also significantly outperformed its benchmark and peers).

As a fund manager I have good access to company management teams, third-party research, professional subscriptions and a network of contacts. I attend conferences (virtually nowadays), capital markets events etc. I have Bloomberg data on tap and qualifications coming out of my ears. And yet a significant number of private investors will have performed much better than me.

Despite the pros having access to more resources, I’d argue they’re at a disadvantage to private investors in other ways. This is why so many active fund managers fail to outperform their benchmarks, and why private investors often fare better.

The drawbacks of managing money professionally


  • Regulation – There are certain regulations that place investment restrictions on fund managers. UCITS funds, for example, must comply with the 5/10/40 rule, which stipulates that no more than 10% of the fund be invested in a single security. Positions in excess of 5% must collectively sum to no more than 40%, meaning a fund with six positions of 7% each would be in violation. This means a manager may be forced to trim back holdings that are performing well, to avoid violating the regulations.
  • Mandate restrictions – Fund managers must comply with the mandate they’ve been tasked to run. A fund sitting in the UK All Companies sector, for example, must invest at least 80% of the portfolio in UK-listed shares. Such restrictions can quickly become drawbacks. For example, if overseas holdings perform well and grow to >20% of the fund, they have to be cut back (regardless of whether it’s the right thing to do from an investment perspective). Likewise, holding an elevated level of cash, even temporarily, isn’t possible. Some funds have quite specific mandates. Income funds must deliver a certain level of income, placing considerable restrictions on the types of companies held and how the portfolio is run. This is why so many UK equity income funds have underperformed the FTSE All Share.
  • Employer restrictions – The investor’s employer may place further restrictions on fund managers that go above and beyond those dictated by regulation. For example, the employer may place limits on the amount of a business the firm as a whole can own. If there are multiple fund managers at the same firm who all wish to own the same stock, such restrictions can soon become limiting. Some of these rules and restrictions may well be sensible. However, placing shackles on talented fund managers is also likely to reduce their performance potential.
  • Liquidity constraints – Professional investors bump up against liquidity restraints all the time. Even a comparatively small fund with £200m of assets will struggle to own meaningful amounts of small and micro-cap businesses. A 3% position in a £100m company would require owning 6% of the entire business. It’s feasible, but this position could take several weeks or months to trade in and out of. This is why most professional investors tend to steer clear of very small businesses, or they run excessively diverse portfolios to avoid owning too much of any one business. The limitations of this approach should be evident.
  • Inappropriate incentives and behavioural biases – Most professional fund managers can’t afford to have long time horizons. A year or two of poor performance and they risk the sack. This problem is compounded by the short-term behaviour of many private investors, who pile in to funds that have recently performed well and sell those that are having a tougher time. Short-termism is further fuelled by the incentive structures of professional investors, which often do little to encourage long-term thinking.
  • Benchmarks and risk committees – Risk committees will often set parameters for fund managers, including tracking error (the amount performance can deviate from its stated benchmark), beta (a measure of volatility) and other, largely meaningless metrics. This means instead of focusing purely on generating the best long-term returns, managers are constantly focused on how their funds are performing relative to the benchmark. This means they’ll often copy benchmark positions whether they like the business or not, and own many more holdings than they need to. Instead of viewing risk the correct way – as permanent loss of capital – they’re more concerned with how much they’re losing relative to the benchmark, and limiting volatility. Private investors tend to care much more about absolute rather than relative risk and returns. This isn’t how most fund managers or risk committees think, and it leads to bad decisions.
  • Managing flows – Open-ended funds receive daily inflows and outflows of money from new and existing investors. If inflows exceed outflows the fund manager has fresh cash to invest. For net outflows the manager must raise cash to meet redemptions. Fund flows tend to be pro-cyclical – during times of market panic, the manager will normally have to raise cash, when their stocks are most cheaply valued. When everything is rosy and money is flowing in, the manager may have little choice but to buy more of their existing positions. These constant inflows and outflows mean professional investors have a lot more buying and selling decisions to make than the typical private investor. Trading incurs costs and most fund managers, frankly, aren’t very good traders (numerous studies have shown fund managers are particularly bad at selling stocks). Constant outflows also exacerbate liquidity issues, as Mr Woodford found out, because the smaller positions are harder to sell and can quickly become a larger percentage of the dwindling assets.
  • Fees – Active managers charge fees, which eat into returns over time. Fund managers are judged on their performance after fees. This is a key reason why many active fund managers underperform their benchmarks.


The advantages private investors have


Private investors, by contrast, are enormously advantaged in the following areas:

  • They only answer to themselves – not regulators, employers, risk committees or other investors – and can act accordingly.
  • They have no restrictions on where or how to invest, and don’t have to worry about benchmark positioning or performance.
  • They can adopt a genuinely long-term investment horizon, measured in years/decades.
  • They can run their winners for as long as they want.
  • They can run more concentrated portfolios.
  • They don’t have to deal with daily inflows/outflows so can avoid forced buying/selling of securities.
  • They can keep their fees low by minimising transaction costs and choosing low-cost platforms.
  • They typically have limited liquidity constraints so can own as much or as little of a business as they like, including small and micro-caps where the best opportunities are often found.
  • They can usually trade in and out of positions quickly and easily.

Don’t get me wrong – there are some superb active funds, run by highly talented managers. But they are in the minority. The success of this group stems, in large part, from their willingness to ignore conventional fund manager ‘wisdom’, and run their portfolios in a similar fashion to how they would manage their own money.

In effect, the best fund managers have learned how not to think like fund managers.
This article was originally published by and is here republished with permission.

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