The Rules, Part XXIV

Every excess eventually unwinds.  When an excess unwinds, the fall gets exacerbated by trend-followers blowing out of mutual and other pooled funds with lousy relative performance.


If you had a list of who owned a given publicly-traded asset, and when they bought it, you would know a lot about how patient, intelligent, indebted, etc., the holders of the assets are.  That would give some insight into how they might behave if the asset’s price began to fall.  Would they buy more as it went down, or would they sell in a panic?

Now no one has this data, but some approximate the data by a variety of measures.  Dollar volume traded as a fraction of market capitalization is a measure of speculative activity, though truly, I suspect that the holders of most stocks fall into two camps — long-term (years), and short-term (days to months).  Short-term has gotten shorter as computer power has democratized trading.

We can also read the lists of holders from 13F data.  Managers are pretty consistent.  If they are low turnover, they tend to stay that way.  The same for high turnover.

The holders of mutual funds tend to be late to the news.  There are two reasons for this:

  1. They aren’t paying close attention because the results of mutual funds give slow and unclear signals, which only become clear when the quarterly statement arrives.
  2. Because of loads, and brokers who sold the investors on the funds, regret causes reactions to be slow.

But these holders are late liquidators, and cause funds with bad investment strategies to sell some of their favorite wrong investments, which drives the prices of the investments down further.  This can cause assets to overshoot below their fair value, which value investors quietly accumulate.


Long horizon investors tend to resist momentum.  Short horizon investors tend to follow momentum.  Long horizon investors tend to have little short-term need for results.  Short-horizon investors want/need results soon.  At bottoms, long-term investors dominate.  At tops, short-term investors dominate.

Mutual funds are in general short term investors, but the few that try to educate their investors that they are long term value investors do get more patient holders, which gets reinforced if the returns are good over a long period.