Tuesday, February 17, 2015

Three Categories Of Investors

This was from a magazine called Derivatives Strategy (dead link), and by "investors" the author was talking from a sell side perspective about buyers of structured products.

In my mind, I grouped investors into three basic categories. First there were the simpletons. They'd say "Wow, I can get 3 percent over there, but I can get 6 percent over here. I don't really understand it, but I want it." They didn't even ask how they were getting that coupon. They just wanted to buy something that would go up when rates went down.

Second were the selfish investors who understood what they were doing but had their own agenda. Maybe their agenda was yield enhancement, maybe it was their bonus. They figure they'd buy a structured note and hold it for a short time while earning the above market rate; it would help the fund's performance. If you're a mutual fund manager, you get a salary and a bonus based on your performance and on how big your asset base grows. If you could buy a bond that could give you an above market coupon, you could report in your newspaper ad that your current yield was higher than your competitor's. New money would flow in and then you'd collect a big bonus. These guys were smart. They were in and out of these trades in six months or less.

The third class was the smart, sophisticated players. They really knew what they were buying and wanted to buy it because they had an economic rationale for taking a position in the market or because they could not use OTC derivatives and had no other way to put on the trade. I didn't talk to many people like that. I don't know if my experiences are representative, but there seemed to be a lot of accounts that I would put somewhere between the simpletons and the selfish.
Simpletons, selfish, and sophisticated. A lot of retail investors are simpletons - that would be the category that buys things based on dividend yield.

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