- Your edge is what sets you apart from other investors.
- It can be informational, analytical, or behavioural.
- Morningstar favours analytical advantages—interpreting accessible information in an unconventional way.
Investing is edgy.
Well, that’s probably not something you’ll hear people say all that often. But let’s break it down: what’s your investing edge, and how can you sharpen it?
‘Edge’ is jargon – the kind of phrase that separates the veteran investors from the up-and-comers. It’s not complicated: your investing edge is your advantage; the thing that makes you a successful investor. Warren Buffett has several—he’s a reader, he’s not afraid of making mistakes, and he genuinely loves investing. He gets that being contrarian is one of the smartest things an investor could do.
The edge concept also applies if, for example, you’ve chosen a managed fund helmed by an investor who’s trying to exceed an index’s returns. If that’s what you’ve opted for, you’re pinning your hopes on an investor who you believe has an edge over their competitors.
An investing edge typically falls into three categories: informational advantages, analytical advantages and behavioural advantages. So what makes each of these valuable?
When you have an informational advantage, you’re sitting on information that’s still relatively unknown*. It can be difficult to find legal informational advantages, particularly now that there are more stringent securities regulations. Combine that with the internet creating easier access to information, as well as stronger individual investor advocacy (including a lot of work by Morningstar), and uncovering informational advantages requires a lot more effort than it once did. Though even that isn’t stopping some investors: consider the story of the hedge fund that hired satellites to count cars in parking lots to guess a retailer’s future sales.
Note that this is a good thing. Improved transparency is great for the investing community, but also means that informational advantages are less and less likely.
Analytical advantages are arguably more likely than informational advantages, but you’re really depending on the people you’re working with. Unlike an informational edge, an analytical edge doesn’t require hush-hush information. Instead, it relies on a keener or more unorthodox interpretation of widely available information. Maybe it’s a quantitative model that can look at key security or economic metrics more effectively, or maybe it’s an investor who knows their chosen industry back to front and can prophesise how changes will affect their stocks.
The analytical edge is Morningstar’s preferred advantage. Our research and Next are grounded in three main analytical principles: sustainable competitive advantage, valuation and margin of safety.
Want to get more abstract? Behavioural edge is for the thinkers; the investors who want to try gaming their own psyches. This is because humans are hardwired to make poor investing decisions: we’re grounded in fear and greed, and too often this translates to buying high and selling low (despite conventional wisdom). Even with sophisticated models and theories that determine when you should buy or sell a security, panic tends to be the more powerful motivator than foresight. Morningstar’s own fair value estimate was created to sidestep reactive errors, so it’s not affected by changes to security prices. However, the Morningstar Analyst Ratings are affected by price movements, so in these cases, investors would do well to separate themselves from the equation and find the resolve to ride out a volatile market.
In short, having an edge means that you don’t necessarily need to be a savant stock-picker devising formulas to game the market; nor do you need to buy a stack of drones to predict a company’s performance. Instead, it’s more often about keeping a clear head and a strong stomach, with a long-term vision that isn’t swayed by the inevitable peaks and troughs of the market. It’s also about being strategic with the information you have. This goes for both professional investors and individual investors: patience, focus, and the ability to see the bigger picture will pay off. After all, it worked for Buffett.
*Note that we’re not talking about insider information—while it’s undoubtedly an advantage, it’s an illegal one. Hopefully, this goes without saying, but let’s err on the side of caution.
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