Can an amateur outperform Wall Street professionals?

I have been investing on my own for 11 years now. There have been frightening moments, like the 50% decline in 2009, but by and large, I have outperformed the indexes handily, often by huge margins. I have never found a year when I could have done better simply by sticking to an index fund.

I’ve puzzled over why I had been able to do well. I don’t have access to Bloomberg terminals with the latest news and charts, nor am I able to call up management and suppliers and do the scuttlebutt work. My competitors on Wall Street are intelligent and motivated, many with advanced degrees and years of experience. I just read annual reports, and think. By all reason, I should not be able to outperform the professionals. Yet, I apparent do. Over the years, I have come up with some reasons for my outperformance.

Firstly, asset-gathering Wall Street mutual funds are often more concerned with form over substance. In December, funds clear out their holdings of out-of-favor stocks so that they do not have to be reported on year-end statements, and increase their holdings of popular appreciated stocks. Christmas is a busy time for me, as cheap stocks often get cheaper, whereas overvalued stocks tend to become even more overvalued, due to the window-dressing trades of the funds.

Secondly, fund managers are often only as intelligent as their customers. Funds often receive influx of funds after recent outperformance, and are drained of funds after a period of underperformance. While there are fund managers who are talented and hardworking and can handle these fund flows, these flows tend to work against generating good returns. Lazy fund managers who simply plough additional funds into existing names, and forced liquidation of cheap stocks by managers experiencing fund outflows, may be an explanation for the momentum effect in the stock market.

And lastly, of course, Wall Street is decidedly short-term in outlook. From a practical point of view, since being too early is indistinguishable from being wrong, I can sympathize with the short-term orientation that fund managers have. It is relatively easy to outperform in the long-term; Wall Street professionals are paid big bucks because outperforming in the short-term is difficult, and they are expected to deliver. Still, the pervasive long-term blindness among fund managers, where any cash flow beyond the next quarter or next year is discounted beyond reason, does not help returns. For these reasons, I have long ago lost faith in mutual funds and ETFs, and have adopted a DIY approach to managing my finances.

That said, one should also have respect for the Wall Street professionals as opponents. You do not want to go mano-a-mano with them in situations where they have the advantage. I stay well away from investments which depend on how a lawsuit is resolved, how likely a buyout will be consummated, or how a key person will react. Basically, any situation where insider news is likely to be material, or legal considerations are important. I assume that professionals on Wall Street will always have up-to-date gossip and rumors about insiders, and excellent legal help from their army of lawyers. I try to stay in situations where there are uncertainties about how the underlying business will perform. In short, I like investments where developments on Main Street matter much more than developments on Wall Street. Despite my best efforts, once in a while, I am still caught unawares by developments on Wall Street, but by and large, I have done moderately well over the years.