Don't Fall for This Pro Trick

You can learn a lot about investing by looking at how experts invest. But before you blindly follow the experts, you need to understand that some pros do head-fakes that can mislead you into making big mistakes with your money.

Every quarter, a host of hedge funds, mutual funds, and other institutional investors reveal their investment portfolios for all the world to see. Inevitably, the latest moves from the most popular fund managers get a lot of attention, as investors try to discern what trends the top market pros are following. The key, though, is that the disclosures that institutions make represent only a snapshot in time, and by the time you find out about them, they could be completely out of date.

Form 13F and you
SEC rules require certain institutional investors to reveal their holdings on a quarterly basis. About six weeks after each new quarter starts, you'll hear about the "latest moves" from super-investors like Warren Buffett, George Soros, and plenty of high-profile Wall Street pros.

For instance, take a look at what we've learned over the past week:

  • Warren Buffett continued to boost his new positions in technology stocks. With his stakes in IBM (NYSE: IBM  ) and Intel (Nasdaq: INTC  ) rising substantially in the past quarter, Buffett has shown that he's giving up his aversion to big tech -- and focusing money on proven stalwarts that have navigated changing trends successfully.
  • George Soros continues to believe that international stocks have a lot of promise. One big increase he made during the fourth quarter was in Baidu (Nasdaq: BIDU  ) , which has continued to post huge growth numbers as the Chinese search giant seeks to expand its geographical reach beyond the most populous nation in the world.
  • A review of hedge funds from Credit Suisse showed that hedge funds are also following the tech trend, pushing into stocks like Yahoo and Google. Meanwhile, Philip Morris International (NYSE: PM  ) has become a less-liked stock, perhaps due to the threat of international cigarette regulations looming over the global tobacco giant's growth prospects. Similarly, Pfizer (NYSE: PFE  ) is out of favor as it deals with the patent expiration of Lipitor and ongoing challenges to the business.

It's great to get insight into what top investors are doing. But that information is only as reliable as the investors making it.

Understanding disclosure
The thing about 13F disclosures is that they only represent positions held as of the end of the quarter. So the news that we've just gotten in the past week doesn't say what those funds own now, but rather what they owned at the end of December.

That opens the door to some particularly nasty tricks. One of the worst is window-dressing, which involves fund managers buying winning stocks and selling bad performers right before each quarter-end, so that for disclosure purposes, it appears that a fund has made only smart decisions. Of course, those moves can't change the actual performance during the quarter, but it can at least make criticism of specific bad picks much more difficult.

Less sinister is the fact that changing conditions require fund managers to take action. For instance, during January, many of the stocks that performed worst during 2011 were among the best performers in early 2012. That may well reflect new investment decisions among hedge funds and other institutional investors -- decisions that wouldn't show up on the Dec. 31 disclosure snapshots at all.

Follow the (right) leader
That's why it's important to take fund disclosures with a grain of salt. If you know that a certain investor has a long-term perspective, then there's less chance of window-dressing and other misleading practices having a big impact on what the fund discloses. But even then, recognizing that your information is out of date can help you avoid doing exactly the opposite of what a fund manager may have done yesterday, last week, or even more than a month ago.

The best stock picks are ones you make for the long run, regardless of what short-term focused fund managers may be doing. Find out everything you need to know from the Motley Fool's latest special report, where you'll find three attractive stock ideas for those investing for retirement. The report is free, but don't wait -- click here and read it today.

Fool contributor Dan Caplinger learned way too many tricks the hard way. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Yahoo, Philip Morris International, IBM, Intel, and Google. Motley Fool newsletter services have recommended buying shares of Yahoo, Intel, Google, Pfizer, Baidu, and Philip Morris International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is always a treat.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 21, 2012, at 4:13 PM, gilsh wrote:

    No offence meant, but most of the warnings mentioned in this article, do not apply for people wishing to follow Warren Buffet.

    You just need to make sure you are up-to-date.

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