Years ago, when working in the investment field, I became familiar with the popular phrases, "smart money" and "dumb money."
"Dumb money" refers to the average "retail" investor, who typically buys a stock or other investment on the basis of something he overheard at the barbershop.
"Smart money" refers to the professional investors and money managers, such as the guys/gals who run mutual funds, hedge funds and pension funds. They invest on the basis of years of experience and knowledge, using incredibly detailed models that are sophisticated enough to make NASA blush.
On Wall Street, Dumb Money is often scorned, as their lack of knowledge and their lemming-like, blindly-follow-the-crowd investing style gets them into trouble time and again.
The Smart Money, on the other hand, is revered. These highly-regarded - and highly-compensated - men and women have devoted the better parts of their careers to learning the ins-and-outs of investing. They're smart, sophisticated, and they know how to use Excel.
There are many investors out there who try to figure out what the Smart Money is doing. Before investing in a particular stock, for example, they look at the percentage of the stock that is owned by institutional investors, particularly the shops that have become household names: Fidelity, Janus, etc. The thinking is that you want to buy what the smart guys own, and sell when they get out. In some ways, this is like going to the race track, and always betting on the same horse as the mysterious guy wearing the enormous, diamond-encrusted pinky ring, who wears sunglasses on the most overcast day, never sits in the front seat of his own car, and always seems to need two people to help him put on his overcoat. Actually, it's nothing like that at all. I just like the imagery.
Now, to be sure, the Dumb Money usually is pretty dumb. The average investor doesn't know nearly as much about investing as he/she thinks he/she does, and typically spends less time doing research before investing his/her life savings than he/she would do before buying a milkshake. In addition, the odds are simply stacked against the individual investor. It's not a matter of being smart or dumb, rather, the average individual investor doesn't have access to the information that the professional investors have. The SEC tried to do something about it in 1999, with the implementation of Regulation FD (Full Disclosure), which stated that firms could not selectively disclose material information. In other words, if during the course of a presentation to the investment community, the CEO of company XYZ tells a group of analysts and fund managers that he anticipates that the company's sales will exceed prior estimates, the company must immediately release that information to the general public, say, via a press release. However, despite this regulation, the information asymmetry (as the academic community likes to refer to it) persists.
Based on this, the Smart Money should generally perform better than the Dumb Money does. Certainly, they're not prone to the types of silly mistakes that the Dumb Money regularly makes.
Or are they?
Let's take a look at the current economic mess. The government had to bail out Fannie Mae and Freddie Mac, who appeared set to crumble under the weight of bad mortgage loans for which they were providing guarantees. Bear Stearns no longer exists, as they were sold to JP Morgan Chase a few months ago in a fire sale arranged by the Federal Reserve. At that point, absent a sale of the firm, the 80+ year old firm, a veritable bastion of Smart Money in the fixed income world, would have been bankrupted by their investments in mortgage-backed securities which can best be described as "toxic." Hedge funds, assumed to be smartest guys of all, are having a dismal year. According to Hedge Fund Research, Inc., hedge funds are having their worst year since 1990, when tracking began. According to Hedge Fund Research, the average hedge fund is down about 3.4% for the year, through the end of August. While that's better than the S&P 500's drop of 12.6% over the same period, the fact remains that you'd have been better off just leaving your money in the bank.
We haven't hit bottom yet, either. Lehman Brothers, the fourth-largest investment bank in the U.S., has seen its stock price decline by 74% this week . And the week's not over yet. Lehman's problems stem from the fact that they're not only the largest underwriter of mortgage-backed securities, they actually bought a ton of these securities. They "got high on their own supply." And it was some nasty supply at that. The stock's tumble was precipitated when it became clear that the firm, which desperately needs to raise capital, was unable to secure an investment from state-owned Korea Development Bank. Korea!? Our 158 year-old investment banks are looking to Korea for help?! What's next, Vietnam is going to help shore up Merril Lynch's balance sheet? How the mighty - and "smart" - have fallen. I'm not sure if there's any truth to the rumor that the Lehman-Korea Development Bank deal fell apart over a disagreement that arose when Lehman's chairman, Richard Fuld, agreed to sit down to eat hot dogs with the Korean contingent, only to find out what they really meant by "hot dog." Sorry, that was too easy. In any event, I predict that before the end of 2008, Lehman Brothers will cease to exist.
It gets even worse. Washington Mutual, the largest savings and loan in the U.S., has seen its stock fall to a 17 year low. WaMu has seen billions of dollars in losses on its loan portfolio. The people who are supposed to know more than anyone about lending money to the masses simply made bad loan after bad loan. Will Washington Mutual continue to exist? What will be the cost of the FDIC bailout of that institution?
So, I guess that the Smart Money isn't so smart after all. In the end, they're just like you and I. Just like individual investors will buy a stock because their neighbor owns it and has made money on it, the institutions will buy a security - any security, the more complex the better - if someone else's trading desk has created some profits with it. The only real difference, then, is in the outcomes. When Dumb Money is wrong, it results in a loss of money, at worst, someone's life savings are wiped out. When Smart Money is wrong - really, really wrong - we're all filled with the urge to run home and hide under our beds.
...so we can be close to the money we've stashed under the mattress.
"Dumb money" refers to the average "retail" investor, who typically buys a stock or other investment on the basis of something he overheard at the barbershop.
"Smart money" refers to the professional investors and money managers, such as the guys/gals who run mutual funds, hedge funds and pension funds. They invest on the basis of years of experience and knowledge, using incredibly detailed models that are sophisticated enough to make NASA blush.
On Wall Street, Dumb Money is often scorned, as their lack of knowledge and their lemming-like, blindly-follow-the-crowd investing style gets them into trouble time and again.
The Smart Money, on the other hand, is revered. These highly-regarded - and highly-compensated - men and women have devoted the better parts of their careers to learning the ins-and-outs of investing. They're smart, sophisticated, and they know how to use Excel.
There are many investors out there who try to figure out what the Smart Money is doing. Before investing in a particular stock, for example, they look at the percentage of the stock that is owned by institutional investors, particularly the shops that have become household names: Fidelity, Janus, etc. The thinking is that you want to buy what the smart guys own, and sell when they get out. In some ways, this is like going to the race track, and always betting on the same horse as the mysterious guy wearing the enormous, diamond-encrusted pinky ring, who wears sunglasses on the most overcast day, never sits in the front seat of his own car, and always seems to need two people to help him put on his overcoat. Actually, it's nothing like that at all. I just like the imagery.
Now, to be sure, the Dumb Money usually is pretty dumb. The average investor doesn't know nearly as much about investing as he/she thinks he/she does, and typically spends less time doing research before investing his/her life savings than he/she would do before buying a milkshake. In addition, the odds are simply stacked against the individual investor. It's not a matter of being smart or dumb, rather, the average individual investor doesn't have access to the information that the professional investors have. The SEC tried to do something about it in 1999, with the implementation of Regulation FD (Full Disclosure), which stated that firms could not selectively disclose material information. In other words, if during the course of a presentation to the investment community, the CEO of company XYZ tells a group of analysts and fund managers that he anticipates that the company's sales will exceed prior estimates, the company must immediately release that information to the general public, say, via a press release. However, despite this regulation, the information asymmetry (as the academic community likes to refer to it) persists.
Based on this, the Smart Money should generally perform better than the Dumb Money does. Certainly, they're not prone to the types of silly mistakes that the Dumb Money regularly makes.
Or are they?
Let's take a look at the current economic mess. The government had to bail out Fannie Mae and Freddie Mac, who appeared set to crumble under the weight of bad mortgage loans for which they were providing guarantees. Bear Stearns no longer exists, as they were sold to JP Morgan Chase a few months ago in a fire sale arranged by the Federal Reserve. At that point, absent a sale of the firm, the 80+ year old firm, a veritable bastion of Smart Money in the fixed income world, would have been bankrupted by their investments in mortgage-backed securities which can best be described as "toxic." Hedge funds, assumed to be smartest guys of all, are having a dismal year. According to Hedge Fund Research, Inc., hedge funds are having their worst year since 1990, when tracking began. According to Hedge Fund Research, the average hedge fund is down about 3.4% for the year, through the end of August. While that's better than the S&P 500's drop of 12.6% over the same period, the fact remains that you'd have been better off just leaving your money in the bank.
We haven't hit bottom yet, either. Lehman Brothers, the fourth-largest investment bank in the U.S., has seen its stock price decline by 74% this week . And the week's not over yet. Lehman's problems stem from the fact that they're not only the largest underwriter of mortgage-backed securities, they actually bought a ton of these securities. They "got high on their own supply." And it was some nasty supply at that. The stock's tumble was precipitated when it became clear that the firm, which desperately needs to raise capital, was unable to secure an investment from state-owned Korea Development Bank. Korea!? Our 158 year-old investment banks are looking to Korea for help?! What's next, Vietnam is going to help shore up Merril Lynch's balance sheet? How the mighty - and "smart" - have fallen. I'm not sure if there's any truth to the rumor that the Lehman-Korea Development Bank deal fell apart over a disagreement that arose when Lehman's chairman, Richard Fuld, agreed to sit down to eat hot dogs with the Korean contingent, only to find out what they really meant by "hot dog." Sorry, that was too easy. In any event, I predict that before the end of 2008, Lehman Brothers will cease to exist.
It gets even worse. Washington Mutual, the largest savings and loan in the U.S., has seen its stock fall to a 17 year low. WaMu has seen billions of dollars in losses on its loan portfolio. The people who are supposed to know more than anyone about lending money to the masses simply made bad loan after bad loan. Will Washington Mutual continue to exist? What will be the cost of the FDIC bailout of that institution?
So, I guess that the Smart Money isn't so smart after all. In the end, they're just like you and I. Just like individual investors will buy a stock because their neighbor owns it and has made money on it, the institutions will buy a security - any security, the more complex the better - if someone else's trading desk has created some profits with it. The only real difference, then, is in the outcomes. When Dumb Money is wrong, it results in a loss of money, at worst, someone's life savings are wiped out. When Smart Money is wrong - really, really wrong - we're all filled with the urge to run home and hide under our beds.
...so we can be close to the money we've stashed under the mattress.
2 comments:
may I suggest opening a second carwash--I mean blog--for these off-topic financial rants? You may easily put your broader audience to sleep before they have a chance to divine the intrinsic comedy.
I found this interestin! Rabbim There is always the option to not read the blogs you find boring. Unless you are looking for the comedy :)
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