A Hierarchy of Advisor Value

I talk often with lots of advisors of all sorts and from a wide variety of firms. They are profoundly disillusioned an astonishingly high amount of the time. When the markets are strong, they are disappointed that they didn’t capture enough of the upside. When the markets are weak, they are apoplectic that they didn’t avoid the downturn. When markets are sideways, they’re just plain frustrated. When they try to anticipate these movements they usually fail and when they don’t – a very rare event indeed – their next moves inevitably don’t keep up the good work. They hate seeming to start from scratch every day and living from transaction to transaction, dependent upon the machinations of markets for survival.

This profound disillusionment is well-earned, of course, and is predicated upon three primary problem areas: execution; expectation; and erroneous priorities. The basis for each of these problems can be established in surprisingly short order.

In terms of execution, the trade ideas they offer rarely turn out well and the performance provided by money managers, when they go that route, almost never meet expectations such that it’s not unfair to say that much of the money management business has been an abject failure pretty much across-the-board, even for the mega-rich. Poor investor behavior makes that dreadful performance even worse — we trade too often, at the wrong times and into the wrong instruments. We chase returns via managers, sectors and trades that have been hot only to be disappointed when mean reversion inevitably sets in. Our inflated expectations make matters worse still because investors expect outperformance as a matter of course and investment managers tell them to expect it, implicitly and explicitly. That’s what makes the sale after all.

Erroneous priorities include a failure to manage to personal needs, goals and risk tolerances as well as “plans” that change with every market movement. It shouldn’t surprise anyone that clients with huge appetites and tolerance for risk when markets are rallying frequently want to go to cash at the first sign of trouble. At the advisor level, the priority problem is even more fundamental and encompasses each of these problem areas. Much of what tries to pass as “financial advice” is actually glorified (or even not-so-glorified) stock-picking. In my experience, most advisors and their clients wrongly think that the advisor’s primary function is to pick good investment vehicles.

Advisors are well aware of the failures of the money management business, of course, as well as the limitations of a transactional business model. That’s a big reason why their disillusionment is so existential. They have been let down again and again by the idea that they have (finally!) come up with a formula for success only for reality to crush those promises. Even worse, and consistent with that conundrum, a 2012 study from the National Bureau of Economic Research concluded that financial advisors reinforce behavioral biases and misconceptions – the problems outlined above – in ways that serve the advisors’ interests rather than those of their clients.

Still, many of these advisors keep hoping against hope. They routinely tell me that if they proposed a data-driven, evidence-based approach with their clients that actually had a reasonable chance for success, their clients wouldn’t perceive a need their services. Not so coincidentally, that’s a big reason why so many advisors are terrified by the proposed Department of Labor fiduciary rule with respect to retirement accounts. And that’s why the Dilbert cartoon reproduced below about index funds (one possible data-driven approach but hardly the only one) is so wickedly funny.

Hierarchy 1

Proper advisor priorities begin with a recognition of what is important and what is achievable. That’s why I have created this hierarchy of advisor value, which was developed for a presentation I have been giving to groups of advisors. Hierarchy of Advisor Value (wide)(ATM)

Managing to this hierarchy won’t make the markets any less infuriating, but doing so will make the financial advice business much more fulfilling and gratifying. It can even make that business more lucrative, at least over the longer-term. Simply put, it will require carefully and truly putting the client’s interests first, even when the client doesn’t see it that way.  Continue reading

Do the Opposite

My friend Ben Carlson has a (typically) terrific piece up on how market action and sentiment impact us. It’s hilarious and true, especially on a day like today with oil and stocks desperately seeking a bottom. Here’s a taste.

Bull Markets: Fear of missing out.
Bear Markets: Fear of being in.

Bull Markets: I knew I should have had more of my portfolio in stocks.
Bear Markets: I knew I should have had more of my portfolio in bonds.

Bull Markets: That guy’s been calling for a crash for years — he’s an idiot.
Bear Markets: That guy just called the crash — he’s a genius.

I encourage you to read it in full.

I also encourage you to watch the video version below. Be careful out there.

“That’s What They Offered”

trump-and-sandersBernie Sanders and Donald Trump are strange bedfellows to be sure. But they were the big winners last night when the first primary votes of the 2016 presidential campaign are cast and counted in New Hampshire as each won astonishing and overwhelming victories in their respective party contests. Let’s be clear. They didn’t just win. They each won by huge margins. And their successes have badly embarrassed party leaders and pundits.

These very different candidates have some surprising commonality. They have each found a rich vein of popular (and populist) support as insurgents attacking the insidious corruption wrought by big money in politics. They see the political fight they are waging not as an ideological struggle so much as a class war. They want to gain control of the presidential process and the political parties at its heart by hostile takeover. As they see it, since the system is rigged, only someone not beholden to big-money special interests can make things right. Continue reading

Cool News

NEAL_MedallionThe Jesse H. Neal Awards were created in 1955 to recognize and reward editorial excellence in business publications. Unbeknownst to me, ALM (publisher of Research magazine, for which I write a regular column) nominated me in the Best Commentary category using three of my columns (see below). My editor now tells me that I have been named a finalist. I am deeply honored. Other finalists include CIO, Investment News, and Crain’s. The awards ceremony is April 1 in NYC.

The three submitted and thus nominated columns are linked below. I hope you will read them (or read them again).

Finding What We’re Not Looking For

We all suffer the ongoing delusion that we’re the center of the universe. We focus first and foremost upon ourselves and tend, most often, to focus on everything and everyone else only as they relate to us, both literally and figuratively.

The great writer David Foster Wallace spoke eloquently, movingly even, about this egocentric delusion in a fantastic commencement address he delivered at Kenyon College in 2005 in a way that just might help to loosen the hold of this delusion on those of us able to hear what he had to say. The speech is delightfully summarized and excerpted in the short film from The Glossary embedded below. Please take the time to watch it in full. Please. The voice you hear is Wallace’s.

According to Wallace, if I don’t make a conscious decision about how to think and what to pay attention to, I’m going to be miserable a lot of the time. That’s because our natural default setting is that everything is self-centered. And that everybody else is in my way. And it isn’t even a choice (it’s a default setting). Continue reading

The Great Myths of Investing

GreatMythsAs the great Mark Twain (may have) said, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” That’s particularly true in the investment world because we know, to a mathematical certainty, that avoiding errors provides more bang for the buck than making correct calls and generating outperformance. Fixing what we “know for sure that just ain’t so” provides a remarkable opportunity for investment success.

On the other hand, it simply doesn’t make a lot of sense to spend enormous amounts of time and energy looking for a strategy or a manager that might (but probably won’t) outperform by just a little bit. As the great Spanish artist Pablo Picasso put it, “Every act of creation is first of all an act of destruction.” What we want to do is to find the next great investor, the terrific new strategy, the market sectors that are about to heat up or the next Apple. But what we should do is eliminate the things that make it so hard for us to get ahead. Accordingly, I will highlight some of the great myths of investing — ideas that lots of people, alleged experts even, claim to be true and act as as though are true “that just ain’t so.”

There are lots of myths at work in our lives, of course, falsehoods that are often believed and which are used to further a favored narrative. But George Washington didn’t really cut down a cherry tree and wax eloquent about not telling a lie as a consequence. Isaac Newton didn’t come up with his theory of gravity because an apple fell on his head. Columbus didn’t discover that the earth was round (that had been established centuries before). Ben Franklin didn’t fly a kite in a storm and discover electricity. And Einstein never flunked math. If any of these are news to you, I’m sorry to have had to break it to you.

Such myths persist because they “work” in some way. Their story elements — ease of recall, readily adaptability, explanatory power — make them useful and even important.  But utility and truth are hardly the same things and neither are utility and helpfulness.

So here is my list of the top ten great myths of investing. Since they aren’t true and are indeed damaging, if you can eliminate them from your mind and your investment process, your results will necessarily improve. Continue reading

Bear Territory

After every football victory, the California Golden Bears declare that the ground on which they stand is Bear Territory. “You know it! What? You tell the story! What? You tell the whole damn world this is Bear Territory!” Watch this particularly lively rendition after a win in The Big Game over Stanford (starting about 1:20 in; my youngest is at the top of the screen and was number 46 for Cal).

Lots of experts and alleged experts in recent days have been declaring that we’re in a different sort of “bear territory” as the market has gotten off to perhaps its worst start to a year ever. Continue reading

Trumping Truth with Stories

trackingtrump

One of the few consistencies of a wild 2016 presidential campaign thus far is that Republican frontrunner Donald Trump is willing to spin, obfuscate, exaggerate, misdirect, deflect, lie outright and double-down when called out for having done so. And, so far at least, it’s working. Truth – literal factual accuracy – just doesn’t seem to matter to him or to his supporters (who recently shouted “Sieg Heil” and “Light him on fire” at a black protestor in Las Vegas). If it feels right to them and fits into their favored narratives, from their perspective it is deemed true. What actually happened could not be less relevant.

This post-truth worldview isn’t a new-found tactic now that the Donald has entered the political world. For him, it has been a consistent way of life designed to benefit the Trump “brand.” He has thus routinely inflated his supposed net worth, often by billions of dollars, to make himself appear far more financially successful than he actually is. And he keeps claiming that his campaign is self-funded (because he’s really rich, donchaknow) when it demonstrably isn’t. But his Pinocchio-like behavior hasn’t been limited to things that, if believed, offer an obvious benefit to the Donald. Continue reading

Here We Go Again: Forecasting Follies 2016

Forecast 2

Image from xkcd

In a great scene from the classic film, The Wizard of Oz, Dorothy and her friends have — after some difficulty and fanfare — obtained an audience with “the great and powerful Oz.” When, during that audience, Dorothy’s dog Toto pulls back a curtain to reveal that Oz is nothing like what he purports to be, Oz bellows, “Pay no attention to that man behind the curtain,” in an unsuccessful effort to get his guests to focus their attention elsewhere.

Like the Wizard, the great and powerful on Wall Street would have us pay no attention what is really there — “behind the curtain.”  Yet once in a great while the Street rats itself out so that we get to find out, beyond a shadow of doubt (if you still had any), what the big investment houses really think about what they do and who they do it to.

The now-defunct Bear Stearns won a noteworthy 2002 legal decision involving former Fed Governor and then-Bear Chief Economist Wayne Angell over advice he and the firm gave to a Bear Stearns client named Count Henryk de Kwiatkowski (really) after the Count lost hundreds of millions of dollars in a just a few weeks (really) following that advice by trading currency futures on margin. The Count had been born in Poland, escaped invading Nazis, been banished to Siberia by the Soviets, escaped and travelled across Asia on foot to Tehran, talked his way into the British Embassy, became a renowned RAF pilot, moved to Canada, became an engineer, and made a fortune trading used airliners, most famously selling nine 747s to the Shah of Iran over a game of backgammon in the royal palace (really). He also became the owner of the famous thoroughbred racing institution, Calumet Farm (really).

Bear offered the Count “a level of service and investment timing comparable to that which [Bear] offer[ed its] largest institutional clients” (which is not to say that they were any good at it). The key trade was a huge and ultimately disastrous bet that the U.S. dollar would rise in late 1994 and early 1995. At one point, the Count’s positions totaled $6.5 billion nominally and accounted for 30 percent of the total open interest in certain currencies on the Chicago Mercantile Exchange. The jury awarded a huge verdict to the Count but the appellate court reversed. The appellate judges determined, quite conventionally, that brokers may not be held liable for honest opinions that turn out to be wrong when providing advice on non-discretionary accounts.

But I’m not primarily interested in the main story. Instead, I’m struck by a line of testimony offered at trial by then-Bear CEO Jimmy Cayne that does not even show up in subsequent court opinions, despite extensive recitals of the facts of the case. The generally “cocksure” Cayne apparently thought that his firm could be in trouble so he took a creative and disarmingly honest position given how aggressive Bear was in promoting Angell’s alleged expertise to its customers. Cayne brazenly asserted that Angell was merely an “entertainer” whose advice should never give rise to liability. Continue reading