Manias, trends, and simple fads often sweep through the stock market. Whether it's tulips or tech stocks, the Nifty 50 or housing, when a wave builds momentum, its inexorable forces move the market . until it no longer does. Then it crashes on the shoals of reality.
One of the latest trends I see getting kicked around is a strategy called "proxy investing" -- investments in other vehicles that stand in for broader themes. Yes, it's been around for a long time -- investments in banks with sizeable stakes in foreign countries, for example, was one way to get exposure to countries that were previously closed to investments -- but now it's becoming a more hip thing to do.
Auction house Sotheby's (NYSE:BID) was seen as a proxy for investing in highbrow art that most investors were unable to afford. Exchange-traded funds (ETFs), another investment mania these days, is a way to get in on just about any possible trend being played out. Even Wade Cook, who once ran a multimillion-dollar investment-seminar company and wrote popular investing books (but was also hit with fraud and tax-evasion charges), touted the benefits of proxy investing.
Perhaps not as sophisticated or dangerous as some other investment strategies, proxy investing can be just as harmful to your portfolio if not done right. There needs to be an identifiable situation that has no meaningful investment associated with it: foreign-country opportunities, certain exotic fuels or metals, art, and collectibles. These are not easy entries for investors because there are few, if any, pure-play stocks in the industries.
It's not simply a matter of buying a stock that has a component of an industry as part of its business. You don't buy General Electric (NYSE:GE) as a proxy for investing in television because it has NBC as a subsidiary. The effect is too washed-out. Microsoft (NASDAQ:MSFT) is not a proxy for computer software, because you could just as easily invest in Electronic Arts (NASDAQ:ERTS) or Activision (NASDAQ:ATVI). You need to find a company that has a large -- even predominant -- exposure to the field that has no readily identifiable alternative. Not so easy to do.
Unfortunately, proxy investing is not the only dangerous trend. Until recently, it seemed that every small investor wanted to be able to invest in hedge funds. These arcane vehicles that were usually reserved for the super-rich were now suddenly opening their doors to investors with a much more minuscule net worth than the typical client. And the hedge funds were getting positive press, too. They were no longer the domain of the mysterious George Soros trying to capitalize on movements in currencies. Hedge-fund managers had morphed into "activist shareholders" effecting positive change and wringing value from the hands of greedy management. It probably shouldn't have been a surprise that a hedge fund like Amaranth Advisors would ultimately implode.
Trading in currencies, or forex contracts, is another sophisticated investment strategy that had once been the preserve of the monied class but has opened up to us lesser individuals. And it's not that regular investors shouldn't have access to these unique opportunities. We should. It wasn't all too long ago that financial advice was out of reach for most individuals, but a pair of Fools created a service that made investment information far more accessible and understandable.
And that's the crux. Many investors who enter into foreign exchange trades or give their money to hedge funds or place their bets on the latest go-go stock story don't understand the investment they're making. They're putting their money in a certain place because that's the place to be. It's hot. It's what everyone's talking about around the water cooler. And it's dangerous for the uninformed.
With the renewed interest in "proxy investing," investors may find themselves substituting common sense for profits and end up with little to show for it. If proxy investing, or investing in hedge funds, currency trades, or even tulips was so easy and profitable, everyone would be doing it, and we'd all be millionaires. As we're not all sitting on the beaches of Los Cabos sipping mojitos shows that the hype might be stronger than the reality.
Microsoft is a recommendation of Motley Fool Inside Value . Electronic Arts was recommended by Motley Fool Stock Advisor . Whatever your investing style, the Motley Fool has a newsletter proxy to match. Take a 30-day free trial today!
Fool contributor Rich Duprey does not own any of the stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.
