Individual Investors Can Outperform

All you do-it-yourself stock investors out there, take heart and smile!

''We find that a sizeable fraction of all individuals that are active in the stock market
are able to consistently outperform the market.''

The above surprising and welcome conclusion comes from the recent research paper Performance Persistence of Individual Investors, written by Limei Che, Oyvind Norli and Richard Proestley of the Norwegian School of Management. The paper was presented at the Northern Finance Association Annual Meeting, that took place Sept.28-30, 2007 in Toronto, hosted by the Schulich School of Business of York University. You can download the original paper from the Schulich site for the conference. Click on the program pdf on that page. The link to this and all the other papers is within the pdf. A big thumbs up to Jonathan Chevreau for posting about the conference on his blog.

The image and the conclusion of individual investor incompetence, admittedly documented by impartial studies (which are cited in the paper; also, see references in books like What Kind of Investor Are You? previously reviewed in this blog) and constantly reinforced by the financial industry who want us to use their services, is not necessarily true. Now, it is possible that only individual investors on the Oslo stock exchange (those studied in the paper) are smart enough to outperform the index by a country mile and that Canadian, German, Chinese, US, UK, Japanese etc investors are stupid and rash......

Here is a chunk of the paper's abstract with more of the good news:
''We find that a substantial number of investors exhibit economically and statistically significant performance persistence. This is robust to how we measure past performance, how often investors trade and whether investors are small or large. Unlike the evidence from mutual and pension funds, the persistence in performance we uncover is not concentrated in investors with poor prior performance. We also show that forming a portfolio that is long in stocks previously favored by top performing investors earns a substantial risk adjusted return in the future.''

The outpermance is persistent too - i.e. it last for several years, unlike results for mutual funds and pension funds, whose outperformance, when it does occur, tends to quickly go back to average or under-performance, which is why chasing last year's hot fund is a formula for disappointment.

Maybe there's a market to be developed here? It's also well-known that stock newsletters and forecasting services don't do well on predictions. However, the missing ingredient might be the ''putting your money where your mouth is'' factor. Someone who publishes their own portfolio has laid their fortunes on the line and those who are proven to be good at it, if this paper's conclusions can be generalized to other markets, have created something of value.

As for me, I'm sticking for now with the cautious average of ETF index investment. No doubt, those individual investors who do outperform must spend considerable time and effort to make their stock choices.