Outsider on the inside track

It is always refreshing and informative to hear an outsider's view of your own market.

It is always refreshing and informative to hear an outsider's view of your own market. "And what should they know of England who only England know?" was how Rudyard Kipling made the point, in his The English Flag, saying without a perspective from overseas, it is easy to fall into static ways of thinking.

It is always refreshing and informative to hear an outsider's view of your own market. "And what should they know of England who only England know?" was how Rudyard Kipling made the point, in his The English Flag, saying without a perspective from overseas, it is easy to fall into static ways of thinking.

Nowhere is this more important than in thinking about ways of investing your money when you are not clouded by concensus opinions. If you are an active investor, doing what everyone else is doing remains a sure path to mediocre performance. These thoughts are prompted by stimulating meetings with one of America's best-known and most impressive investment advisers, Ken Fisher, who has just opened an office in London.

Most of the time, Mr Fisher sits and ponders the world's markets from his hilltop office in California, where his firm, Fisher Investments, is based. Last month, he came here for the formal launch of his new operation, seeking a niche as a specialist player in the market all big financial firms are now targeting, looking after private client money.

Mr Fisher has a distinctive style of investing, a powerful reputation in his own country and a promising-looking product offer, combining a commitment to personal service, relatively low charges and a sophisticated investment process that makes the average UK private bank or broker look amateurish.

My guess is that Mr Fisher stands in the private client advisory business where Goldman Sachs and Fidelity stood vis-Ã -vis investment banking and fund management when they opened shop in the UK. But a new firm always takes time to break into an overseas market, given the entrenched positions of many incumbents and the conservatism or chauvinism of many potential clients. But without, I hope, being accused of a lack of patriotism, it is frankly impossible to doubt that new competition of this sort will be a force for good.

I am constantly impressed by the depth of knowledge and commitment the best investment professionals from the States, of which Ken Fisher is undoubtedly one, bring to their work. It was said of Nigel Lawson that he would happily cross the road to pick a fight with someone he disagreed with, and I suspect Ken Fisher is cut from the same cloth.

He is never afraid to challenge conventional opinions, nor to speak his mind. I also like the way he actively tries to incorporate findings of the exciting new field of behavioural finance into his investment process, recognising that the way the world works is rarely the way in which it is meant to work in theory.

Mr Fisher's starting assumptions are two. One is that the today's financial markets are broadly efficient, in the sense that most information is quickly absorbed and reflected in market prices. The second, which, in part, follows from the first, is that markets are also frequently capricious.

Investors, in Mr Fisher's view, are driven by psychological and social impulses that leave them vulnerable to the whims of what he calls The Great Humiliator, his description of markets that routinely confound the expectations of all participants, not least its most expert practitioners.

One example is annual market forecasts, which are invariably and demonstrably wrong. Each year, Mr Fisher compiles his market forecast, based not on economic fundamentals, but on an analysis of what all the other professional forecasters predict. By narrowing the field to outcomes nobody else is predicting, his chances of being right are hugely improved (I have seen the figures for the past few years, and they support his argument).

Another distinctive feature of the Fisher approach is that he is interested in investment styles, the notion that certain categories of investment approach tend to perform better at times than others. Value versus growth, and large-cap versus small-cap stocks, are the two best-known examples of competing investment styles.

Mr Fisher's point is that deciding whether to weight your portfolio disproportionately with large- or small-cap stocks has a much bigger bearing on your eventual investment returns than individual stockpicking can hope to achieve.

The reason is that when markets are inclined to favour large-cap stocks, that factor tends to dominate share price movements far more than any other factor which separates one share from another. Although last year was an exception, with smaller companies enjoying a renaissance, most of the past few years have been dominated by the exceptional performance of just a few large-cap growth companies.

One simple strategy to beat the market - which Mr Fisher has employed for several years in the US - is to construct a portfolio that consists of equal-size holdings in the small handful of companies whose market capitalisation is greater than the average of the main market index.

This need not involve buying a large number of stocks. In April this year, it would have meant buying just eight companies in the FTSE All-Share index. Backtesting suggests, as the table shows, that anyone who bought equal amounts of the 10 largest companies in the index at the start of each of the past five years would have comfortably beaten the market over the same period. Sounds simple? Well, many of the best investments are simple. Of course, nothing works forever, and strategies such as these tend to stop working as soon as they have been publicised.

Mr Fisher believes large-cap stocks will continue to outperform for most of the time; the only time, historically, that you tend to see small-cap stocks outperforming significantly is in the early stages of a bull market. It is true, in aggregate, that small-cap stocks have a slightly superior track record over the long run, but the years of outperformance are few. If you blink, you may miss them.

The underlying message is that choosing the right style, rather than stockpicking, is what determines the success of your investment strategy. Mr Fisher has many more insights to offer, though he is also the first to admit he is far from infallible (it is one of the jobs of The Great Humiliator to make sure of that).

The key point is that his approach is refreshingly different to that adopted by most UK advisers in the same field. Time will tell if it is also commercially successful, but it looks a good odds proposition to me that he may be in the money.

davisbiz@aol.com