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Private investors don't have the pros' advantages ? fortunately for them

Cover of  by Lee Freeman-Shor

The small investor has as good a chance of reaping profits from shares as any professional fund manager ? if not better

"It?s a waste of time trying to pick your own shares ? City fund managers have so many advantages that they will always be ahead of you.?

It?s a complaint you often hear from frustrated private investors. But two stories published this weekend by Telegraph Money show how shaky this supposition is.

This first reports some fascinating research carried out by Lee Freeman-Shor, a ?fund picker? at Old Mutual. He wondered why it was that the fund managers to whom he entrusted his clients? money often had a less than 50pc success rate of selecting stocks that turned out to rise ? but still produced good returns from their portfolios as a whole.

It sounds almost impossible. But it results from the fact that the gains from running a few big winners outweigh the losses from the losers, particularly if they are quickly recognised as such and sold.

Let?s say you plan to run a portfolio of 10 shares, and put £10 in each. Nine go bust, but the last one rises by a factor of 20 over the course of a few years (this does happen; think of Asos and Hutchison China Meditech). Your ?failure? rate ? the ratio of winners to losers ? is nine to one, but you?ve still doubled the value of your portfolio.

Here?s another way to look at it: as a normal investor in shares, your losses are limited (to the amount you invested) but your gains are theoretically unlimited ? there?s no absolute limit on how high a share price can go.

One of the supposed advantages of professional investors is that they can ?short-sell? ? sell a share they haven?t bought (but only borrowed) in the hope of buying it back later at a lower price. But with short-selling the situation above, of unlimited potential gains and limited losses, is reversed. So perhaps private investors are in fact rather fortunate not to be able to short?sell.

The second advantage that fund managers are supposed to enjoy over private savers is access to company executives. But one successful manager, Jeremy Lang of Ardevora, believes that meeting the bosses of the firms he is thinking of investing in is more of a curse. He sees them as overconfident ?spin-merchants?, who could distract him from the real business of examining the firm?s books in exhaustive detail.

In fact, the idea that those inside the financial system are their own worst enemies has a long pedigree. John Maynard Keynes, famous as an economist but also a very successful investor, also believed that careful analysis of a company was more valuable than inside information.

? How to invest like ... John Maynard Keynes

He said: ?The dealers on Wall Street could make huge fortunes ? if only they had no inside information.?

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