Newbie Thought: What Type of Investment Edge Do You Have?

I was listening to this Manual of Ideas podcast with James Roumell and he briefly mentioned the three  types of edge investors could have and I thought it was worth thinking about. The three of them are:

1. Information edge
2. Analytical edge
3. Behavioural edge

There are many different ways of slicing and dicing the idea of investment advantages that are required but these three do a good job IMO.

This is a very simple thing but it is always worth thinking and periodically reminding oneself about basic concepts in investing.

Information Edge

Information edge is when you have knowledge that most others--say the market as a whole--doesn't possess. Some people do it through illegal means but we are talking about fully legal activities here. It sounds like James Roumell believes this may his edge. Those with large budgets may get an edge by sourcing information that is not easily accessible to others, either due to cost or exclusivity (for example, getting very detailed market research data, or foreign country data). In most cases, it involves acquiring information that the market doesn't know about by talking to customers, competitors, management, and so forth. It might involve going to industry conferences, physically visiting the company, checking out the goods/services being sold, etc.

Essentially, scuttlebutt and hitting the road.

Warren Buffett used to do a lot of this in his early days of investing. For instance, he used to count railroad cars, or go to government agencies/libraries to search for public records no one else bothered looking at. I'm not sure how much this helped Buffett but he did suggest several times that he gained a lot of knowledge from his early scuttlebutt-type work and because of that, he didn't do it later on.

I think if I was a professional investor, I would do more of this. If you are a professional investor, you should seriously think about seeing if you can develop an information edge somehow (Roumell suggests others do more of this as well). Not everyone is suited for this but you never know until you try.

Having said that, it is usually hard for amateur investors to develop an edge this way. There are two difficulties with trying to get an edge this way. Firstly, it is costly, hence not worth it if you have a small portfolio. You have to pay quite a bit to acquire information (such as market research data or highly specialized industry reports). It can cost thousands to attend industry conferences or subscribe to industry trade journals.

Secondly, amateur investors just don't have time. Even if you are dedicated to investing and it is your primary hobby, you only have a few hours per day. It's kind of hard to go to conferences or visit numerous locations and so on. Maybe you can get away with it if you are only looking at local companies where you live but otherwise it's tough. I find that even listening to the quarterly conference calls, which don't really give you much edge since everyone listens to them (it's more to just "keep up" and understand basic things), is already time-constraint.

Analytical Edge

Developing an analytical edge probably looks the easiest, but is likely the hardest. You have to be naturally talented or develop above-average investing skill through experience and knowledge.

This is the one that most amateur value investors gravitate towards, at least from what I see on the Internet. Certainly this is the one that you can do sitting at home.

I don't have much to say on this because it isn't easily explainable--investing has elements of art and science--and only a few will outperform, although there are multiple paths. There isn't one way to analyze an investment.

This is probably Warren Buffett's greatest strength. The way he analyzes companies is truly remarkable and unmatched by anyone. He is a superstar for sure. It's amazing how he can look at financials that are available to everyone else and make a decision within a few hours. In fact, he does that even when there is very limited information, as with most private companies he buys. It's just amazing. I am also impressed whenever I look at some investments that look "dumb" whenever everyone else, including me, look at them but turn out to be very good. His purchase of high P/E companies in low growth, mature, industries involve superior analysis and I'm always impressed by them.

Small investors are probably on an even level with professionals when it comes to analytical edge. Professionals do have teams of analysts that help them out but one person's superior analysis is better than a whole committee of decision-makers.

Behavioural Edge

People may have differing views of what a behavioural edge is, but I take it to mean that you don't succumb to "bad behaviour." Namely, you shouldn't blindly follow the crowd; you need to do something a little bit different from others; and so on.

Amateur investors probably have an automatic edge in this but it is hard to master. It's probably something you are born with. Professional investors will have a difficulty with this because fund management is very pro-cyclical and correlated with bull markets. Fund manager's behaviour matters less than what the fund investors do: when fund investors start pulling money out during corrections, it's hard for fund managers to act independently.

To sum up, in a simple sense, there are three ways to have an edge on the market and the rest of the competition. So, which of these are you good at? Which one can you beat most others with? Something to think about.