Penny shares: still the best kept secret in finance

If you hold shares in Arm Holdings (ARM) you might be feeling pretty pleased with yourself. ARM has been the best performing share in the FTSE 100 share index in 2010, rising 74%. If you hold Aggreko (AGK) you can give yourself a pat on the back. It ranks second, gaining 41% this year. Coming in third isLloyds Bank (LLOY), weighing in with a 33% gain. Not bad.

But here in the penny share market we laugh at such measly gains. We are shooting for much better. The best performing shares on AIM in 2010 are Blinkx (BLNX), Rockhopper (RKH),Encore Oil (EO.), and Petromatad (MATD). Shares of these companies have gained respectively 543%, 514%, 454% and 424%! The list of penny shares that have doubled in price this year is long and varied. ARM's 74% performance would hardly appear on page one.

And yet financial advisers continually steer investors away from this very area in which there is real money to be made! It drives me crazy!

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The most overpaid job in Britain

In my opinion, the standard of financial advice in this country is absolutely dire, driven entirely by the vested interests of bigfinance.

The last thing the finance industry wants is for you to pick your own shares and make your own trades. What the industry wants is for you to hand over your money to the professionals, have it stuck into funds that routinely underperform, and pay a fat fee for the privilege.

Writing in the Evening Standard last week Anthony Hilton quite correctly argued that the public's appetite for investment into shares is being gradually whittled away by poor returns, and by the failure of fund management groups to deliver on their promises. I entirely agree with this.

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Fund management is probably the most overpaid job I can think of. The people who work in these firms are not especially bright, and the fees that they skim off their clients' money would be outrageously high even if they were. But most of us go along with this institutionalised rip off because we don't know any better.

There is another nasty downside to this behaviour - a widespread ignorance about what really matters when it comes to investing.

Take this example.

It doesn't matter what the market thinks

Time and again I turn on the radio and hear some voice opining on 'the market'. Is it going to go up or down? Are shares good value or bad value? Will interest rates go up or down, and will this be a good thing for shares or a bad thing?

Now forget the fact that if you ask the same question to three economists you will get four different answers. Forget the fact that nobody has ever come up with a failsafe method of predicting the near term course of the stock market.

What really winds me up is the fact that nobody need invest in 'the stock market'. All we need do is invest in companies. Maybe one or two. Maybe we will build a portfolio of ten or fifteen. Maybe we will spread our eggs a little further and hold thirty or forty shares. But the point is this.

All that matters is that we invest in successful companies. They should be financially sound, competently run and have genuine, identifiable prospects for the future. Maybe, as in the case of an oil explorer, they are more speculative. That does not necessarily matter. They are still proper commercial enterprises driven by the need to make profits.

The best kept secret in finance

Now I'm not saying you should invest all your money into penny shares. They are far too risky for that. A lot more can go wrong with a penny share.

And if the company is hit by disaster, it can often be hard to shift the stock quickly. Sometimes you even have to be prepared to lose all your investment. That's why it's important to maintain a diversified portfolio.

Still the real money is not made by the huge sluggards of the FT index. These big stuffy companies have overpaid directors, countless committees for risk management and corporate governance and institutional investors who prop them up from one disaster to the next for no better reason than that they are big concerns that can soak up a lot of the money that fund managers have to invest.

Thanks to the relentless focus on the big picture of 'the economy' and 'the market' and thanks to the efforts made by fund managers to gather all our money together into big boring funds, direct investment into penny shares is still the best kept secret in finance. But I have no doubt at all that the best returns over the next few years will come from small companies. The property market is dead in the water, deposit rates are derisory, and all those big companies are going nowhere.

This article was first published on 16th September in Tom Bulford's twice-weekly small-cap investment email The Penny Sleuth.