The risks of copycat investing

If you bought a stock just because a big investor did, you could be hit when the stock goes through a bad patch

Making money from stocks may look easy as pie in a bull market, but regular investors know that unearthing winners is far from easy. One short-cut that has gained ground globally is copycat investing, also known as coat-tailing or side-car investing.

Copycat investors simply keep an eagle eye on the investment moves of a renowned market wizard, and faithfully replicate his or her buys and sells.

While investors in the US markets look at the quarterly portfolio filings of large funds to hang on to their coat-tails, Indian copycat investors have multiple sources to rely on.

Quarterly shareholding updates filed with the exchanges can reveal new investors who own more than 1 per cent equity. Monthly portfolio disclosures of equity funds can tip you off to buys and sells.

Bulk deals data disseminated daily by the exchanges, post market hours, can tip you off to trades in which more than 0.5 per cent of the outstanding equity in a stock changed hands.

Of late, there are also many investment blogs and fan sites ( gurufocus.com, rakesh-jhunjhunwala.in, alphaideas.com, for instance) dedicated to tracking the above filings and offering readymade data on what your favourite investors bought or sold. Lately, there’s also the social media, where legions of followers eagerly seek stock tips from well-known money managers on Twitter.

But if you’re a newbie investor who thinks that making big money in the markets is as simple as following a Rakesh Jhunjhunwala fan site, or mimicking the bulk deals of Porinju Veliyath, Ramesh Damani or Mohnish Pabrai, you’re quite mistaken. Copycat investing carries risks.

Not knowing the whys

Often, big money in the stock market is made not through the act of swooping in on the right stock, but by holding on to it through thick and thin. This kind of perseverance requires a lot of conviction about the business and your reasons for owning a piece of it. If you simply bought a stock because a big investor did, and didn’t pay much attention to the business, you could experience a lot of mental turmoil when the stock goes through a bad patch.

SEBI’s recent crackdown on ‘shell companies’ abruptly suspended daily trading in 331 stocks. Among the stocks that were hit were Prakash Industries, where Rakesh Jhunjhunwala owned a 1 per cent stake (June 30 shareholding) and J Kumar Infraprojects, where a clutch of top mutual funds owned stakes (July 2017 portfolio disclosures). Now, when hit with this thunderbolt, a Jhunjhunwala or a HDFC Mutual Fund may assess the business and decide to hold on, if they believe the company has a fundamentally-sound business that will eventually shake off this crisis.

But if you’re a copycat investor who hasn’t studied the business as deeply, it will be hard not to panic.

Too stock-focussed

Even stock market wizards do make mistakes. This May, Warren Buffett admitted to making a blooper in buying IBM six years ago and said that he had sold a third of his position in the preceding months. Rakesh Jhunjhunwala’s bet on the 2010 IPO of A2Z Infra Engineers backfired, with the stock losing over 75 per cent in the two years after the IPO.

What makes Buffett or a Jhunjhunwala ace investors is not the fact that they never make mistakes, but the fact that they own large portfolios where winners far outnumber losers.

Copycat investors are often focused on finding out the latest big bet made by their idol and don’t bother to look at their entire portfolio. By mirroring the individual buys or sells of big investors, they run the risk of picking up their duds, while missing out on their winners.

Delayed information

The price at which you acquire and liquidate a stock in your portfolio can be a big decider of returns. Copycat investors who look to public sources or social media for tips from their gurus, may get delayed or half-baked information.

Professional managers who oversee portfolios for private clients or investors will seldom tip off the market to their buy or sell decisions before they make them. After all, doing so will bid up or batter down the price of the stock they want to buy or sell, and undermine the investors’ returns.

Even private investors may not want to tip their hand to the markets while they’re in the process of building or liquidating a position. On July 21, the stock of debt-laden infrastructure player, Jaiprakash Associates, soared by 17 per cent after the company’s shareholding disclosure for June 30, revealed a 1.03 per cent stake held by Rakesh Jhunjhunwala.

The March 31 holding didn’t feature this stake. Many copycat investors no doubt hopped on to the risky infrastructure player, believing that Jhunjhunwala had picked up the stake this quarter. But it is quite possible that he held a less than 1 per cent position earlier, which he only topped up.

Stomach for risk

Rather than look for established names, many copycat investors today are keen to know of penny stocks picked up by big-name investors, which can multiply money in a matter of months.

Now, high net-worth investors may bet on distressed companies or turnarounds, because they are okay with all-or-nothing bets. They may have a risk management strategy in place where they hedge their bets, or only a part of the portfolio is devoted to risky stocks. But copycat investors who follow them may not have an equally sound understanding of risks. They may end up with their fingers singed if these bets backfire.

Overall, tracking the stock moves of big investors can be a useful source of investing ideas. But before you bet your money on it, do your own homework.

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