What is smart money?
Its actions may also move prices. Because of its reputation as a market mover, it is able to attract many followers who also join in the purchases, causing stock prices to move further. If smart money can make money most of the time, then tracking the investments of smart money and following its footsteps can be a profitable strategy.
In this article, we will discuss several types of smart money, some of which are really "smart" but some may have limited impact on the market.
Accumulation by owners
Owners are supposed to know what happens in their companies. They know the prospects of the company. The future direction of the company is literally in their hands. There are many plans that they have for the company, which may not have been brought to the board for consideration. In many instances, preliminary discussions on deals are engaged by the owners privately.
Many dealmakers prefer to talk to owners who can make immediate decision on a deal, as getting the board's approval is probably just a formality if the owners have already agreed to the deal.
On the other hand, if there are troubles ahead, owners are definitely the first to sense them. If the company is not doing well or if its earnings are not improving, it is unlikely that the owners will buy the stock. They will probably wait for a better time to buy. At least, this is the perception of investors.
Investors will also feel more confident to participate in the stock if the owners have the confidence to buy the stock. Even if the stock price does not go up after a series of purchases by the owners, there is no pressure for other shareholders to sell.
On the other hand, if the market comes to know that an owner has been disposing of his stock in the market regularly or in large quantities, they may become very uncomfortable and wonder what's going wrong. Is there something that the owner knows that the public is not aware of? As such, disposals by owners will have more impact than their purchases.
However, owners of listed companies may have multiple objectives and it could be difficult to read their minds.
? First, the owners may own a big percentage of the company and what they are buying could just be a small fraction of what they own. They may just want to support the share price to instil confidence in the market.
? Second, if the owners pledged their shares to banks (owners' shares under nominees are likely to be pledged), they may need to support the share price to prevent force-selling by banks if the share price falls below a certain level.
? Lastly, owners may also give a false impression of their action, as they may buy smaller quantities under their names but at the same time sell larger amount using nominee names, which is not uncommon in this part of the world.
As such, following this type of "smart money" may not be very reliable. Therefore, we need to know the character of the owners and whether they are credible or not.
Purchases by the EPF
Since most of its investments exceed 5% of the stock's paid-up capital, the EPF make regular disclosures on their purchases and disposals. Sometimes, investors are puzzled why the EPF trades regularly between buy and sell.
The presumably unclear direction of trades is because the provident fund also appoints external fund managers (EFMs) who have the full discretion to buy or sell. As such, sometimes the EPF could be buying a stock but their EFMs could be selling the same stock on the same day.
In certain cases, one EFM buys but another EFM could be selling at the same time or a few days later. Hence, the disclosure by the EPF is a combination of trades by its internal fund managers as well as that of EFMs.
Due to the difference in opinion between the EPF and its EFMs, there is no clear signal of the direction of this powerful domestic fund. The fund could be big, but they are not "united" and they are in fact competing with each other. This is also a way to generate liquidity in the market. As such, relying on the trades of this "smart money" for direction may not be very reliable.
Even if the fund is buying a particular stock persistently, we observe that the stock price may not seem to rise substantially. This may be linked to the way the orders are placed - that is, they tend to buy lower after a completed trade. This is different from the trading style of foreign fund managers, which we shall discuss later in this article.
Actions of local institutions
Since big-cap stocks are widely owned by most local funds, such as mutual funds, insurance companies and asset management companies, for every purchase to lift the stock price, there could be several funds waiting to sell to the buyer. Local institutions are competing with each other to achieve maximum returns as they have their own stakeholders to answer to.
As the market continues to rise, more and more local institutions are seeking investment opportunities in undiscovered stocks and unpolished gems. Research houses are competing with each other to identify growth stocks with good earnings prospects and "good story" to satisfy the appetite of local funds and entice them to buy.
Most of these stocks are the tightly held mid- to small-cap stocks, where the valuation is generally much cheaper than that of the big-cap stocks. If the "story" is compelling, more funds are likely to participate in the purchases. If there are also private placements from the owners or by the company, a stock may attract even more interest and can move quite fast.
A stock may be attractive from various angles, but if there is no liquidity, most funds are hesitant to participate due to the lack of liquidity to get out when the need arises. When funds started to buy a stock, the rise in the share price is likely to bring out some sellers, which will lead to improved liquidity. The subsequent improvement in liquidity will in turn attract even more funds to partake in the "game". If there are sufficient "followers" the stock price will continue to climb; otherwise, it may just fizzle out a short jerk.
As such, local institutions could be a useful "smart money" to follow if they start to have position in smaller cap stocks. A neglected stock may turn out to be a star performer if the stock has been successfully promoted. There are a number of such well-promoted stocks which have performed very well this year.
From our observation, share buybacks seldom have much impact on stock price. Such repurchase of own share will definitely reduce the free-float of the stock in the market, but moving the stock price to a higher level is another issue. Share buyback may clear off some of the weak holders and place the stock in a good position to run if other strong buyers emerge. But for the stock to attract strong buyers, it must deliver results and show growth potential.
Buying by insiders
Because key personnel have unfair advantage over the public, it is illegal to trade on insider information, which unfortunately is very difficult to prove. To reduce the incidence of insider trading, blackout periods for the trading of stock are imposed before the release of important announcements and these include the announcement of quarterly results, right/bonus/split issues and other material announcements, which may have a strong impact on the share price.
The purchases made by insiders are difficult to detect. A sudden share price movement of a stock is usually suspected to be related to insiders who may use nominees to avoid detection. The only way to detect possible insider trading is through technical charts, which may reveal such activities from price movement as well as changes in volume. Otherwise, it is difficult to identify this type of "smart money".
Although syndicated play could be powerful, their movement is very secretive and hard to predict. As a syndicate is out there to make money, they will use all sorts of tactics to achieve their objectives. The tricks may include dissemination of untimely rumours just to lure in other punters to help them to stir the market. Unknowing speculators could be drawn in by their own greed.
Going along with a syndicate is a risky game, as they will not disclose their game plan. They can play one game on the surface but at the same time be selling quietly at the back.
Inflow of foreign funds
There is a number of reasons why following the footsteps of foreign fund managers are more reliable:
? Purchases by foreign fund managers are more dynamic, as they normally push up the share price when buying. In this way, not only can they obtain the quantity of shares required, they can also record immediate price appreciation.
? The quantity allocated to each stock is normally larger, as foreign funds are normally bigger in size and hence have bigger allocations.
? Unlike local funds, which probably have two dozen or more stocks, foreign funds normally select a handful of local stocks to invest.
The strategy of investing by following the "smart money" must be very selective, as many of them are either not very effective or not reliable. It is better to follow foreign funds, which are more powerful and less deceitful.
|Written by Ang Kok Heng|
|Monday, 20 December 2010 11:01|