When you are just starting out investing, there is a temptation to make quick gains. You want to boost your portfolio to a sizeable amount so that dividend collecting can be meaningful. For a person in my situation, taking these calculated quick gain ‘risks’ are worth it because I am still young and just starting out with my journey to be financially free. So if I had to lose money at this early stage, it would be an insignificant amount which I can always make up as time is on my side. One strategy I used to make quick gains was Frontrunning.
Front running is buying or selling a stock based on anticipated upcoming trades that are large enough to significantly move the price of the stock as a result of the added buying or selling pressure.
This essentially means that you buy a stock just before it is added to an index fund. When the stock gets added to the index fund, the index providers need to go out and buy the stock, as an index fund is just a mirror of lots of different companies, and all this huge buying will cause the stock price to rise and the front runner to profit.
Note: Front Running with insider information is illegal. On the other hand, if you use information already available to the public to front run, it is acceptable. The later is what I used to ‘game’ an index fund.
Below is how I used Front running with Woodford Patient Capital Trust (WPCT).
Neil Woodford launched his investment trust, the WPCT, in the summer of this year. And unsurprisingly, it came with a lot of fan fare. Every serious investor was interested in this launch as Woodford has been the premier fund manager in the UK for the past 25 years and has delivered returns in excess of 13% per annum over this term.
The hype surrounding the launch was unprecedented causing Woodford to increase the fund amount. Even after the increase in size, the stakes people could invest in were reduced. And this is when I spotted my opportunity. Because I knew that the demand by people to invest in this find was so high, the price would go straight to premium after launch i.e. the stock price of WPCT would go up up after launch due to people wanting Neil Woodford to manage their money.
Another thing that caught my attention was the fund size. As it was a £800m investment trust, the size would comfortably make it a FTSE 250 company and thus it would need to be added to the FTSE 250 index as well as the FTSE All share index. Once a company becomes part of an index (FTSE100, S&P500, Dow), index providers like Vanguard and Blackrock need to buy sharers in the company in order to place them in their respective index funds. As you can see, the need by the big players to buy this stock will lead to its price rising.
I thus applied for the initial share offer through my online broker. I applied for shares worth £1200 at the face value of £1 a share thus getting 1200 pieces of stock. WPCT started trading on April 21 2015 and immediately went to premium. Over the coming days and weeks, the price kept rising as investors wanted to own a share of this investment trust and index funds were buying it as it was going to be a component of the FTSE 250 index in the June quarterly index reshuffle. My analysis proved correct.
In early June, I sold 1,014 units of stock worth about £1130.71 at a price above £1.11, which is 11.51% higher than the priced of the initial offering, the price I bought it for. This gave me a gain of 11% in just under 2 month. Just by knowing how the stock market works, how index funds work, I was able to make money.
I still have 186 (1200 – 1014) pieces of stock in the company. This had a market cap of about £200 when I made my sale in early June. I left the £200 in as it is virtually ‘free money’ or house money in casino terms. I have recouped almost all of my initial principle (94%) and have gotten 186 units of stock of the investment trust in the process. A very good deal if you ask me.
If you have the right mindset and the right strategies, you can make quick returns from long term investments.
Why I didn’t invest more for higher return?
The temptation here is to thick ‘what if I invested £5000, I could have has a quick £1100 gain.’ This ‘what if’ type of thinking is what you should avoid. As an investor, your job is to attain the highest return relative to the risk you are willing to take. If the stock price did not jump by 11% but instead stayed the same or even dropped, would you be happy to keep your £5000 in the investment? I thought not. The reason I invested only £1200 even though I knew it would jump on the first day of trading is because just in case everyone else decided to sell on the first day and the price dropped, I would be happy to let my £1000 investment sit in the WPCT stock as I know it is a long term investment.
There is another opportunity at present to benefit from Frontrunning and it is with Harbourvest, a global private equity company. Harbourvest invest across a wide array of private businesses that are not listed on the stock exchange. Some of the hot startups it has invested in is UBER and Snapchat.
Harbourvest is listed on the London Stock Exchange. Although it has a market cap of £690 million , it is not part of the FTSE 250. This is because until September 9 of this year, it was listed as a specialist fund whereas now it is classed as an investment company. As a result of this restructure, it can now be eligible to enter the All share index, and possibly the FTSE250 index depending on the its size on the reshuffle date. The all important reshuffle date is 2 December at which point it will enter either one or two of the aforementioned indexes. This will mean there will be buying activity from index providers as they are obliged to take a holding and this move may see the rice increase.
Although I know there is a great opportunity of getting quick gains like I did with WPCT by gaming index funds using frontrunning, I will not be buying Harbourvest stock. The reason is simple, Harbourvest is a business I do not understand. And remember the key rule, if you do not understand something, it’s best to stay away.
Even though frontrunning has worked for me, only use it in a company that you are prepared to hold for the long term if things do not pan out as expected.
The small gains count in investing
Most people will look at £200 and say that’s minuscule. What they do not see is that the £200 is a driver to more wealth. To most they just see £200, I on the other hand see an amount in excess of £50,000.
If Woodford delivers on his stated returns of 10% per annum, which is a conservative amount for his track record, the paltry sum of £200 will have grown to £66,985 by the time I am Warren Buffets age. Do you still think £200 is too small?
When it comes to investing, no amount is too small if you understand the power of compounding.