Pitfalls of riding another investor's coattails

By DAVID MOON, Moon Capital Management, LLC
May 5, 2013

It’s dangerous to buy or sell an investment simply because someone else is doing it, no matter how smart they are.

Watch the smart money and learn from them. But don’t blindly follow them.

Sometimes the smart money makes dumb decisions.

A recently released study commissioned by the Royal Bank of Scotland reported a surprising new participant in the world’s stock markets: central banks around the world.

Central banks are managers of the world’s money supply and currency reserves. They aren’t hedge fund managers; they’re supposed to be stewards of the money.

Almost 25 percent of the surveyed central banks report that they currently own stocks or plan to. The Bank of Japan plans to double its stock investments in the next year.

Even the Swiss National Bank holds 10 percent of its reserves in equities.

Rather than invest their growing reserves in very short term government bonds, the central banks are behaving like emotional 401(k) investors: they are chasing last year’s winners.

On the surface it might make sense.

The Wall Street Journal reports that based on a stock-to-bonds valuation metric used by former Federal Reserve Board Chairman Alan Greenspan, stocks are currently cheap.

This reminds me of the Federal Reserve Board Chairman advocating investing a portion of the Social Security trust funds into the stock market. The argument made sense to a lot of analysts and investors.

The Fed Chair was Alan Greenspan. The year was 1999.

Stocks were priced at historic high valuations and were only a year away from a two-and-a-half-year bear market that wiped out 45 percent of stock market wealth and began a 13-year period in which stocks returned zero.

So much for Greenspan’s stock-to-bonds valuation metric.

A year ago all of the supposed smart money clamored to buy shares of Apple Computer. The stock was so popular that even a number of short-term bond fund managers had purchased shares of Apple.

Short-term bond funds are supposed to buy short-term bonds, sort of like central banks are supposed to do.

Apple stock has famously fallen 30 percent in seven months.

Apple was again the center of smart money congregation last week, when the company issued bonds for the first time in almost 20 years.

Among the $17 billion in new debt, Apple issued 3-year floating rate bonds at 0.33 percent.

Apple stock’s 2.90 percent dividend is almost nine times the yield on those bonds.

It will be interesting to see how this popular Apple bond investment turns out. I will be watching, not participating.

There are several pitfalls when trying to ride another investor’s coattails. It’s fairly easy to know that Warren Buffett or Timothy Geithner owns a certain investment, but it’s a lot harder to know at what price they bought it. It’s almost impossible to know if they have changed their opinion about an investment until after the fact – often well after the fact.

And sometimes old news is useless news.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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