The Marketocracy Masters 100 Fund is a mutual fund unlike almost any other. Its stock pickers are actuaries, geologists, computer programmers, psychiatrists, waiters and various other amateur investors.
A diverse lot to be sure, but the San Mateo, Calif.-based mutual fund is outperforming the market. Since inception on November, 2001, it has delivered a total return of 75 per cent as of the end of February, compared with a gain of 35 per cent in the Standard & Poor's 500 index in the same period.
Although it isn't available to Canadian investors and its assets under management are still small at $35-million (U.S.), the Marketocracy fund is still worthy of study as it has the potential to disrupt the fund industry if its "crowd-sourcing" approach continues to beat the market.
What makes the fund so unorthodox is Marketocracy.com, a website set up in 2000 by fund founder Ken Kam to give investors a place to practice their skills with $1-million (U.S.) virtual portfolios. The website, which currently tracks over 50,000 portfolios, also serves as a farm team for the mutual fund.
Mr. Kam buys and sells stocks guided by the trading activity and opinions of the top investors on Marketocracy.com. In effect, he is running an actively managed fund that recruits its research talent from Main Street USA.
The best investors are identified through a quantitative process. Mr. Kam and his team have developed computer programs that extensively analyze the performance of the portfolios on Marketocracy.com over different time periods. From this screening process, a list of the top 100 portfolios (m100) is created each month.
Portfolio managers in the m100 group are not one-hit wonders. "We don't look at short-term performance as an adequate comparison," Mr. Kam says. "We require at least a three-year track record of outstanding gains."
The result is a diverse collection of stock-picking talent. Some are "generalists" who outperform with portfolios spread across many sectors, while others are "specialists" who outperform with portfolios concentrated in one or a few sectors, Mr. Kam says.
In contrast to many other actively managed funds, his roster of analysts has talent not just in one sector or investment style but in all departments - and can therefore be called upon to help steer the fund through different market environments.
Each day, the computer produces a report on trading activity within the m100 group. Mr. Kam pays close attention to new and large positions. If they are going against the Wall Street consensus, that is a strong "buy" signal. But before putting in the order, Mr. Kam sends an e-mail to Marketocracy.com members who have the stock in their portfolios, asking for their views.
Once a decision is made to buy a stock, the next step is to decide what weight to give it. The breadth and intensity of viewpoints received from e-mails and one-on-one interviews is one factor. Another is the skill set of the top investors owning the stock, as measured by Mr. Kam's software ranking system.
For example, do their picks tend to be right more often than other investors (i.e. high winning ratio)? When they are right, does the average gain on their stock far surpass the average loss on their mistakes (i.e. good trading skill)? And do they have a consistent record of exceeding the benchmarks for their sector or investment style?
What to buy and by how much is also affected by how well a stock fits in with the existing portfolio. Mr. Kam doesn't want just a collection of best ideas but a set of best-idea stocks that are spread over more than one sector and are driven by different factors.
"A portfolio should be built so that there is no one factor than can bring down all the positions at once," he explains. Some of his best investors may be moving toward an all-energy portfolios but the fund won't follow them all the way. To control risk, the fund's energy exposure will be limited to 25 per cent.
Mr. Kam provides an example of how the stock selection process works. In 2005 he noticed two of the top 10 investors on Marketocracy.com had purchased large positions in Elan Corp., an Irish drug company. Its shares had just plunged by more than 90 per cent after the company's multiple sclerosis (MS) drug, Tysabri, was pulled from the market because of serious side effects.
He asked his two top investors what they liked about the shares and e-mailed the same question to the 1,500 or so other members who had bought them. From the responses, he discovered that medical reports had indicated the fault lay with the interaction with other drugs, not the drug itself.
Also, several Marketocracy.com members afflicted with MS sent back e-mails indicating they still wanted the drug treatment regardless of the side effects. That was enough to tip Mr. Kam into buying the shares for the fund. It's now the biggest holding at over 6 per cent of assets, having more than trebled in value since purchase.
Once a portfolio manager at top-ranked Firsthand Technology Value Fund in the 1990s, Mr. Kam thinks the fund industry is flawed because professional managers are recruited right out of business school and lack firsthand experience in the industries they cover.
"We don't depend on an analyst that has never worked in industry to become smarter than the market about that particular company and industry," Mr. Kam says. "We have detailed trading data on hundreds or thousands of people that are consistently beating the market, great at trading that particular stock, or have firsthand experience with that industry or company."
THE MERITS OF MARKETOCRACY
Nov. 1/ 2001
Management Expense Ratio
1.95 per cent
$34.7 million (U.S.)
(as of Feb. 29)
-4.3% (vs. -9.1% for S&P 500)
Top Five Holdings
Elan Corp. ADR6.9%
MasterCard Inc. 3.3%
DepoMed, Inc. 3.0%
Valero Energy Corp. 2.8%
Tradestation Group 2.8%
HOW IT WORKS
Although membership on Marketocracy.com is free and portfolios use play money, there are certain rules that need to be observed. Specifically, members must run their virtual portfolios according to the same regulatory framework under which U.S. mutual funds operate.
There is no buying on margin or short-selling. Stock positions cannot be larger than 25 per cent of total assets and half the portfolio must be made up of holdings five per cent or less of total assets. The overall effect is to keep a lid on silly, roll-the-dice investing.
In addition, there are several incentives for members to give it their best shot. If they make it into the exclusive m100 club, they will receive cash rewards based on the size of fund's assets (and other perks). Many are motivated by the chance to build a reputation that could lead to second careers as investment advisers.
Other social-networking websites for investors, notably Cakefinancial.com and Updown.com, are planning mutual funds that access the "wisdom of the crowd" on their sites. Cakefinancial.com is different in that real, not virtual, portfolios are tracked. Updown.com has hired Harvard University researchers to develop sophisticated filters to distill information from the site's participants.
And other "mass collaboration" funds, such as StockJungle Community Intelligence Fund and IPS iFund, have come and gone. StockJungle failed because it invested on the basis of what was popular with its crowd - i.e. when most of the good news had already been discounted by the market. IPS Fund folded because decisions were taken by vote and the votes were distributed by the amount of money an investor had deposited. The flaw here is that stock-market talent is not necessarily linked to the size of one's bank account.Larry MacDonald
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