Insider information: investing myths you need to forget

Investors are best off trying not to do anything dumb

I have never liked the expression "smart money". It is demeaning to individual investors and used by commentators to imply they are smart and the rest of you aren't.

But a lot of supposedly smart professionals do some very dumb things, and a lot of non-professional investors, often my clients, do some very clever things.

There are only a few "smart money" activities, inaccessible to the mortal investor, some of which are the domain of substantial funds management institutions; others are only available to the very wealthy and others are a myth.

They include:

Access to IPOs

Being given larger allocations of hot new issues is something only the big institutions get, and they get it because the brokers controlling the issue want to suck up to them to get their secondary market business.

Read the monthly reports of some of the boutique fund managers and you will come to realise that this is a significant source of outperformance for some small and mid cap managed funds.

Individuals can theoretically get access to this sort of action by signing up as a sophisticated investor with a broker.

They are called s.708 investors because of section 708 of the Corporations Act. Under this section, if investors meet the sophisticated investor hurdles they are deemed to be able to evaluate offers of securities (shares) and financial products without needing the usual protection of a regulated disclosure document.

In other words, brokers can sell them stuff more quickly and with less disclosure under the core principles of caveat emptor, buyer beware.

To qualify for your sophisticated investor status, you have to get a certificate from a qualified accountant saying that you had a gross income of $250,000 or more in each of the previous two years or have net assets of at least $2.5 million. The certificate is valid for two years.

All very well but you have to ask, why on earth would you want to qualify for a lack of protection from the corporations law and why would you want to buy anything without a product disclosure statement?

The answer, of course, is that the lower care of duty owed to sophisticated investors enables brokers to offer a select group of investors "exclusive" stockmarket deals that they are not allowed to offer to the unsophisticated investor, a process that often enrages the excluded masses.

So what's the catch, you ask. It's pretty obvious.

You may qualify as a sophisticated investor but are you qualified to be a sophisticated investor?

When the only qualifying criteria are that you are rich, your sophisticated investor moniker can make you more of a target than a champion, and to qualify for the best placements you are going to need a good (regular) rather than simply "sophisticated" (cherry picking) relationship with your broker.

Without that, you aren't going to be at the top of the list. Caveat emptor. That's the catch. The buyer does have to be aware.

Inside information

There is a broker's saying that "if you are not on the inside, you're on the outside" and a lot of private investors think that this is how everybody else makes their money and some would tell you that the stockmarket is one big Machiavellian plot against them. But it's not.

On top of that let me tell you a story. I once stood in a lift with a very experienced professional trader who overheard a couple of brokers talking about an inside tip. He piped up with the line, "If I'd never been told any inside information, ever, I reckon I would be a $1 million better off."

During boom times there is a lot of self-serving information masquerading as inside information, designed to push a price up or down so the author of the misdirection can take advantage of it. I'm sure inside information is around and good luck to those who have it.

I'm sure you can be considered "smart" if you can use it to make money but it's not legal and it's not commonplace in or out of the industry.

The main misconception of those outside the industry is thinking everybody else has it. Quite simply, they don't. That's not the game.

Writing options

Some of the very wealthy investors do very little other than constantly write out-of-the-money call options against large existing holdings in the big stocks.

They do not write naked calls; they own the stocks. But this will only ever achieve incremental gains, a few percent maybe, over and above the total return of that stock.

But if you are not very wealthy and don't hold big stocks, this is not for you.

Yes, you will find some operators offering it as a way to get rich but it's not - it's a way for the rich to stay richer with very little risk. Try to do that from a low capital base writing naked calls and you will be paying a lot in fees and spread and will be taking a lot of risks.

It's not going to make you rich; it is only going to make the provider rich, while you take all the risk.

That's "smart money", although the real quality of smart money is not that its "smart" but that it's not "dumb".

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