The Financial Times published an article this weekend about copy trading.
The article makes a number of interesting observations, on which comments below.
“An equity trader abruptly abandoned his cautious strategy and lost half of the copier’s account.” This example showcases why diversifying your portfolio is important. Anyone can have a bad year, but if the person having the bad year is only a small part of your entire portfolio, you will be able to recover from the loss.
To reduce likelihood of such a large loss taking place, it helps to monitor the people you copy and start asking questions if positions of excessive size are opened or if the strategy being copied seems to change.
“How are people to know if they’re following a fantastic brain or an overinflated ego?” One thing that helps here is analysing the risks taken to get returns. What is the maximum risk score and how much variability is there in the risk score from one week and month to the next? What is the maximum position size? Is leverage used?
Returns that are made with lower, more consistent risk scores, and with more diversified portfolios, are less likely to have been generated by overinflated egos.
“If you [a Popular Investor] succeed, you make more money, but it doesn’t matter if you fail as you can delete your account and gamble again.” This problem will apply most acutely to investors with low copier counts. Those starting out need attention to get copiers. And one way to get attention is to post a fabulous year; and to do that, taking excessive risks helps.
However, after a Popular Investor gets thousands of copiers, incentives change, because people will remember you if you start to gamble and fail.
This is not to say that there won’t be investors with high copier counts who still feel pressure to gamble, because they want to make it to absolute #1. The antidote against this would be that Popular Investors should be required to invest a large part of their liquid net worths in their strategies.
“Several of the most-followed copy traders have started to lag behind after doing well before the pandemic.” I believe this is because the most-followed copy traders became so by being invested in Technology stocks and cryptos. Those assets performed badly in 2022. And they are very unlikely to post similar returns in the 2020s as during their golden years in 2018-2021.
This is an example of a situation where copying based on past returns may have been counterproductive.
“However, novice savers may be following a name rather than an investment strategy and be unaware of the risks involved.” This is undoubtedly true. Diversifying across a number of investors and other assets will help to contain the risks, however.
The challenge for most investors, whether retail or professional, is that it is difficult to identify good people to invest with, and there is no simple algorithm that can guarantee success.
It is in my view likely that only 1-2% of Popular Investors of the 3,000 on the platform have skill. Yet, if you manage to identify the best, then I believe copy trading may well provide superior returns over alternatives such as investing in index funds or actively managed funds over the long run.
(A user comment) “Probably better value for money than St James Place or Odey asset management” This I agree with. The advantages of copy trading over traditional fund or wealth management are several:
– Lower fees
– More transparency
– More interactive and educative
Investing always comes with risks, and copy trading certainly is no exception. But copy trading done right, with the risks appropriately managed, may well be the future of wealth management for retail investors.