Will the smart money stand up?

YOU’VE PROBABLY heard the term ‘‘smart money’’. It apparently describes money invested by knowledgeable people and implies they know better than you, so you should follow their lead.

The question is, who is the smart money? More often than not, retail investors are painted as being somewhat dumb money whereas professional investors, particularly clever hedge-fund types, are the smart ones.

Performance during recent years has turned that theory on its head. Retail investors have successfully avoided big losses by sticking to low-risk investments and cash. On the other hand, many professional investors have become risk-averse and more focused on losing less than making more. They have therefore become more like retail investors and are not deserving of the smart money label.

The other group often referred to as smart money are the superwealthy, with the logic being that if they have lots of money, they must know how to make it.

Again, the label is not necessarily justified, because there are countless wealthy folk who are very good at making money by building and selling businesses but appalling at choosing smart investments.

The most recent reference to smart money came in a flurry of headlines about United States mutual fund flows in January. Thomson Reuters Lipper Fund Flows, a weekly report of flows in and out of mutual funds (which are the same as managed funds) reported US$18.3 billion ($22b) moved into stock mutual funds for the week ending January 9, 2013. Another US$3.76b ($4.5b) moved into stock mutual funds for the week ending January 16, making it the largest two-week rise in that category since April 2000.

Media headlines speculated that smart money had started a trend back into stockmarket investments, implying others should get in quick.

A Lipper analyst was quick to respond that while investors watch where the so-called smart money is heading, individual mutual fund flow trends have not historically earned that title. ‘‘In fact, the retail crowd has often jumped onto certain trends at precisely the wrong time, including the technology stock run-up to the March 2000 market highs.’’ He highlighted that the last all-time-high flows into stock mutual funds happened in April 2000, coinciding with the all-time high on the S&P500 index.

That turned out to be the opposite of a smart move. As for the other smart guys, only 32 per cent of large-cap fund managers beat their benchmark last year, and in the previous two years, barely 20 per cent had done so. As for hedge funds, according to Goldman Sachs, 88 per cent of equity hedge funds lagged behind the market.

Cabot Research, a pioneer in measuring investment skill, says there is no doubt some investors are more skilled than others.

They suggest rather than focusing on the score alone (that is, performance during a given period) the skill of an investor should be determined by breaking down each decision to buy or to sell and learning from that what works and what doesn’t. Carmel Fisher is managing director of Fisher Funds, an investment manager and KiwiSaver provider.