I Hope This Doesn’t Describe You

The new issue of Research magazine is now available online. Its theme is evidence-based investing. I encourage you to read it in its entirety. My contribution is here and outlines some alternatives to evidence-based investing. A taste follows.

The providence-based advisor

An advisor who lacks convincing evidence will often claim that the advice he is giving comes straight from God. Sometimes the claim is implicit, sometimes explicit.

Sometimes the motivator is guilt, sometimes it alleged brotherhood. But the results are usually hellish.

I Hope This Doesn’t Describe You

res-0417-cover

For those of you unwilling to register (it’s free), the full text is reproduced below.

 

There is a new and growing movement in our industry toward so-called evidence-based investing, which has much in common with evidence-based medicine. Given that it’s a relatively new concept — even though the best advisors have always practiced it — it might be helpful to look carefully at some possible alternatives to being an evidence-based advisor.

Here is a baker’s dozen worth of options for your thoughtful consideration. Many were adapted liberally from a piece on evidence-based medicine written by Dr. David Isaacs and Dr. Dominic Fitzgerald for the “British Medical Journal” in 1999. If I’ve missed any category, please let me know.

The eminence-based advisor

This (usually older) advisor wants you to believe that the more senior the practitioner, the less importance needs to be placed on anything so trivial as mere evidence. Apparent experience, it seems, is worth more than any amount of evidence.

These advisors have a touching faith in personal experience, which can be defined as “making the same mistakes with increasing confidence over an impressive number of years.” Such an advisor’s white hair and balding pate are often called the “halo” effect and act to trump substantive knowledge.

His (rarely her) well-appointed suite of offices featuring fine views and paneled wood are usually seen as the best available evidence of quality.

The fear-based advisor

This sort of advisor keeps on shouting from the rooftops that “the end is nigh,” over and over and over again, no matter what actually happens, in order to get you to respond. The idea is that if clients and prospects are sufficiently scared, they will run to the fear-monger for refuge. In other words, quite simply, fear sells.

The crooked advisor

This category of advisor is both self-explanatory and far bigger than generally assumed. For these advisors, prospects and clients are merely opportunities to be exploited by the best available means. They actually do care about evidence, but it’s a very different sort of monetary evidence (cha-ching).

The vehemence-based advisor

This sort of advisor sets out to substitute volume and passion of transmission for actual evidence so as to pummel, cajole and harass prospects, clients and adversaries into believing that he (rarely she) is really good.

The eloquence-based advisor

Proponents of this approach are always smoooooth. They feature year-round tans (even in New York), power ties, fine suits from Barneys, and (especially) a silken tongue. Sartorial elegance and verbal eloquence are deemed powerful substitutes for mere evidence.

The novelty-based advisor

This specimen emphasizes what’s new and unique, the less transparent the better. They always have the latest and the greatest.

Black boxes and hedge funds are prominent in this space — because he (again, rarely she, as is true in most other advisor categories) is so smart, don’t cha know?

The providence-based advisor

An advisor who lacks convincing evidence will often claim that the advice he is giving comes straight from God. Sometimes the claim is implicit, sometimes explicit.

Sometimes the motivator is guilt, sometimes it alleged brotherhood. But the results are usually hellish.

The intuitive advisor

Alleged common sense is often more attractive than real evidence, especially because good investing is often counter-intuitive. Therefore, this sort of advisor will go with his gut about stocks, funds, managers, styles, timing and forecasts.

He will rarely just stand there. He’ll usually be doing something.

The diffidence-based advisor

Some advisors see a problem and look for an answer. Others merely see a problem. The diffident advisor will often do little or even nothing out of a sense of paralysis or despair.

He will do nothing, because he has no good evidence-based idea what to do. This, of course, is most often better than doing a non-evidenced series of somethings. But that’s a really low bar.

The self-righteous advisor

This advisor hoses his clients while remaining utterly convinced that they are doing what’s best for them. He’s often wrong but never in doubt.

No one should be surprised that, in this instance (as well as others), “what’s best” is often really, really good for the advisor. It doesn’t usually work out so well for the clients.

The nervous advisor

Fear of clients being upset and the potential consequences thereof are powerful stimuli for excessive and repeated portfolio changes. Counterintuitively, this sort of advisor is often quite afraid of offering reasonable expectations, because unreasonable expectations are so much more attractive. Plus, they can be counted on to tell clients and prospects what they want to hear rather than what they need to know.

The ideology-based advisor

This sort of advisor is unalterably committed to his market ideology, contrary facts and evidence notwithstanding. They know what’s True (with a capital T) and will stick with that come hell or high water (and beyond).

The publicity based advisor

This category sets out to convince clients of his bona fides via media appearances, publicity shots and name recognition rather than real client service. That’s because he had to become so well known for a reason, right?

As British journalist Robin Powell puts it, “All too often we base our investment decisions on industry marketing and advertising or on what we read and hear in the media” or on something else altogether.

Evidence-based investing is the idea that no investment advice should be given unless and until it is adequately supported by good evidence. Thus, evidence-based financial advice involves life-long, self-directed learning and faithfully caring for client needs.

It requires good information and solutions that are well supported by good (often academic) research, as well as the demonstrated ability of the proffered solutions to work in the real world over the long haul (which is why I would prefer to describe this approach as science-based investing). It means changing one’s mind, approach and strategy when the evidence demands it.

The obvious response to the question about whether one’s financial advice ought to be evidence-based is, “Duh!” Then again, advisors and investors of every sort — those with a good process, a bad process, a questionable process, an iffy process, an ad hoc process, a debatable process, a speculative process, a delusional process, or no process at all — all think that they are evidence-based practitioners already.

They may not describe it that way specifically. But they all tend to think that their process is a good one based upon good reasons. Nothing to see here. Move right along.

But the bald fact remains that all too few in the financial world practice evidence-based investing. Take a good look at the alternatives and carefully consider how evidence-based your advice and your practice really are. Test and re-test your purported evidence for errors, holes and unsupported conclusions.

Investing successfully is really hard. Adding a client component makes it harder still. Even the best advisors are going to be wrong far more often than they would like.

If you want to do right by your clients, keep checking and re-checking your work, your assumptions and your conclusions. The evidence demands no less.

Carolina Crazy

Tonight Duke University and the University of North Carolina will play a basketball game on the Duke campus (ESPN, 8pm ET) and thus renew the best rivalry in all of sports. As ESPN reports, for the 78th time, both teams will be ranked while over the last 96 meetings, each team has won 48 games and scored exactly 7,437 points.

As a freshman, Jay Bilas (now of ESPN) lined up for a foul shot in his first rivalry game next to then All-American and future NBA All-Star Brad Daugherty (and also a current ESPN-er), who looked over at him and said, “I’m going to beat you like a rented mule.” Even so, that comment was astonishingly mild as these things go. Every Duke home game, irrespective of opponent, includes multiple iterations of a single chant cascading down from the rafters of venerable, old Cameron Indoor Stadium: “Go to hell, Carolina, go to hell! [Clap. clap].”

That’s about as close and as serious as it gets.

CraziesI first sat in Cameron as a student in 1978 and didn’t miss a home basketball game while I was enrolled at Duke. Every game was special – and wild. NBC came to Cameron to do the first national telecast from the arena on January 28, 1979 for a game against Marquette (I was there, of course) and insisted on a time-delay so the crowd could be censored if necessary. But Duke v. Carolina was and is something else entirely. The “Cameron Crazies” will be fired up tonight, of course. As legendary Hall of Fame Duke coach Mike Krzyzewski puts it, the game is a “national treasure.” Continue reading

2017 Investment Outlook

2016 brought many wild surprises. The biggest and most obvious is summed up perfectly in two words: President Trump. Donald J. Trump, despite no political or military experience, overcame long odds and became the 45th President of the United States in what many called the biggest upset in American political history.

Almost as surprising was that an avowed Socialist who had honeymooned in the Soviet Union – by choicenearly achieved a major party nomination for president. Indeed, without the fix having been put in by the Democratic establishment, he may well have won it. Across the pond, the United Kingdom shocked political experts and voted to leave the European Union.

In more prosaic matters, the Chicago Cubs won the World Series after 108 years of futility. After 111 years and 29 consecutive losses, Ireland beat World Cup champion New Zealand in rugby. LeBron James led the Cavaliers to the team’s first NBA championship and brought Cleveland its first championship of any sort in 52 years by upsetting the defending champion Golden State Warriors, who had the best regular season record in league history and who led the Finals series 3-1. In Great Britain, Leicester City came from out of nowhere to win the English Premier League championship despite preseason odds against them of an astounding 5000-to-1. And in perhaps the biggest surprise of all, the film Bridget Jones’s Baby made over $200 million.

From a markets perspective, 2016 started off dismally. In fact, it was the worst start to a year ever. Things looked so bad that many alleged experts were proclaiming doom and gloom, led by RBS urging clients to “sell everything” except high-quality bonds and warning of a “ fairly cataclysmic year ahead“ that “all looks similar to 2008.” Later, legendary bond manager Jeff Gundlach offered the same advice. “The artist Christopher Wool has a word painting, ‘Sell the house, sell the car, sell the kids.’ That’s exactly how I feel – sell everything. Nothing here looks good,” Gundlach said. “The stock markets should be down massively but investors seem to have been hypnotized that nothing can go wrong.” Legendary investors Stan Druckenmiller, Bill Gross, George Soros, Jeremy Grantham and Carl Icahn (among many others1) were also prominent members of the “sell everything” club.

But they were all dead wrong. The markets in 2016 were much more mundane than most expected. By the time the calendar had turned from 2016 to 2017, from the time of the initial “sell everything” call, the S&P 500 was up more than 20 percent, emerging markets stocks were up more than 25 percent and oil was up nearly 60 percent. But before we look head to the future, we should review 2016 to make sure we understand the position we’re in.  Continue reading

Nice Press

Above the Market has gotten some very nice press of late, most of it of the “best of” variety. I am grateful for the honor and for the attention. Many other fine publications are included so I hope you’ll check out the links below.

above-the-market-transparent

Hoping for a Regulatory Miracle

res-0117-coverThe newest issue of Research magazine in out and my column is now available online. I hope you’ll read the excerpt below and then give the entire piece, as well as the full issue, a careful read.

In a variety of contexts, the DOL has suggested that it doesn’t think this change to a fiduciary standard for retirement assets is all that big of a deal. And conceptually, it isn’t. It needn’t be a big deal to replace a suitability standard — whereby recommendations must be suitable but not necessarily in a client’s best interest — with a fiduciary standard.

The problem, Santa, is that the DOL, through 1,000-plus pages of regulatory requirements, set up a complex framework that must be followed whenever retirement asset investments are involved. This framework touches every aspect of the BD business and requires a complete overhaul of everything that happens therein: paperwork, systems, technology, operations, oversight and supervision, surveillance, training, compliance and more.

Every BD I’m familiar with has spent enormous amounts of time and money to try to comply with the new rule (which, again, isn’t altogether bad because advisors should be fiduciaries), but almost none of that spending relates directly to client care.

Hoping for a Regulatory Miracle

Climate Change Is Real: The Investing Implications

socal-wildfires

Southern California Wildfires (2007)

My latest ThinkAdvisor article is now available. You can find it at the link below. Here’s a taste.

With the possible exception of the inverting demographic pyramid, I expect climate change to be the dominant investment challenge and opportunity of our time over the long term. But I don’t expect it to play out quickly. For most traders, an actionable item is one that can and should be undertaken right now and is expected to pay off essentially right away. But no matter how often I point out that lunch tomorrow is not a long-range plan, I don’t seem to get heard all that often on this point. What I offer is an action item that will almost surely pay off in the longer term for those with the necessary patience based upon any reasonable interpretation of the available data. The climate is changing and those changes will have to be dealt with sooner or later.

The “skeptics” and even governmental opposition conceptually do not trouble me in the least. As Bruce Chadwick put it, “if your investment horizon is long enough and your position sizing is appropriate, you simply don’t argue with idiocy, you bet against it.”

Climate Change Is Real: The Investing Implications

A Call for Kintsugi Portfolios

Slate advice columnist, Dear Prudence, received this sad and poignant letter seeking guidance earlier this year.

“I keep making terrible decisions and can’t seem to stop.

“Last year I left my home, my family, my friends, a 20-year secure (if uninspired) career, to move 2,000 miles away to be with my first love. I’m 50 and I was his first love as well. He’s married and his wife invited me to their home. We decided to share him, although his wife and I were not interested in one another like that.

“My job here fell through. My dog died. The romance flopped spectacularly. I still love him desperately. And when he told me that it was over and that he didn’t love me and never had, I begged him to reconsider, only to have his wife come in and start screaming at me to keep my f***ing hands off her f***ing husband.

“I snapped. I tried to kill myself. I ended up in a coma and then went to the psych ward. I have been out for only a week. I’m back at work. I’m freshly diagnosed as Bipolar I. I’m on new meds I don’t think are helping. Of course I had to move out and I’m living a very lonely life. I do not feel stable and I cry for hours every night. The loneliness is killing me. I have psychiatric follow-up and intend to do what I can to survive and thrive.

“My former boyfriend is now making noises about wanting to be ‘friends with benefits’ with me once I am ‘well again,’ which sounds more like he wants a self-supporting mistress that he can come and have sex with and then leave at will. I still love him but I realize this is a gross affront to my worth as a human being. I just don’t trust myself to say ‘no.’ Counselling may help but I still don’t trust myself to make good, healthy decisions. Everything I do blows up in my face.

“Any advice?”

We humans are shockingly prone to bad ideas, ideas that routinely grow into poor decisions and then metastasize into behavior that may undermine, severely damage or even ruin our lives and futures (see, e.g., Weiner, Anthony). In the words of Kant, “Out of the crooked timber of humanity no straight thing was ever made.” We share a pitiable and cracked nature desperately in need of a repair job nobody seems qualified to perform. We’d all like to think that we’re a lot better off than the letter-writer above, and most of us probably are (if not nearly so self-aware), but vanishingly few of us has a consistently good track record of decision-making and none of us is as good as we think we are. We’re all too much like the party girl in the Busby Berkeley movie musical Gold Diggers of 1935’s surrealist closing number, “Lullaby of Broadway,” who ends up dancing herself right out of a skyscraper window to her death.

Accordingly, the idea that we act in our own rational self-interest with any degree of regularity is, quite obviously, ludicrous and falsified every single day by our choices and our lives. Worst of all, we readily recognize such self-destructive behavior in others but consistently and tragically lack the ability even to see it in ourselves. As legendary physicist and Nobel laureate Richard Feynman warned , “The first principle is that you must not fool yourself – and you are the easiest person to fool.” The Apostle Paul also (an odd pair for agreement if ever there was one) made the same point (Romans 7:15): “What I don’t understand about myself is that I decide one way, but then I act another, doing things I absolutely despise.” We just can’t seem to help ourselves.

Despite the enormity of this problem, the investment portfolios we design, recommend and manage routinely discount or even effectively deny the overwhelming evidence of our cognitive and behavioral weaknesses and how they impact our financial decision-making and well-being in favor of technocratic attempts at efficiency and optimization. In the immortal words of Pogo, “we [may] have met the enemy and he is us,” but we don’t seem very willing to try to do very much about it.

William Goldman is an Academy Award winning screenwriter, novelist and playwright. He wrote Butch Cassidy and the Sundance Kid, All the President’s Men and The Princess Bride and some other excellent films. He famously said the following about the movies, but it applies much more broadly.

“Nobody knows anything…… Not one person in the entire motion picture field knows for a certainty what’s going to work. Every time out it’s a guess and, if you’re lucky, an educated one.”

Josh Brown stated why perfectly: “People can’t be accurately modeled. And it’s people who work and vote and invest and trade and make deals and stick things into themselves that require a trip to the emergency room.”

This dangerous reality implicit in our portfolio construction choices ignores an irrefutable fact: no matter how fantastic the financial plan or how perfect the portfolio, they don’t do a bit of good if the plan isn’t followed and the portfolio maintained when times, markets, situations and feelings change…as they inevitably do. Or, to turn the problem on its head, as Josh would have it: “You can boil down whether or not a financial advisor is adding value into a single metric, you might even say it’s the only metric that matters: Retention. Do clients stay?” Therefore, a “Mary Poppins” portfolio – “practically perfect in every way” (when the “every way” means analytically and not behaviorally) – won’t usually be good enough, to the extent it even exists.

Our lives change. Our goals change. Our outlooks change. Our situations change. Our risk tolerances and profiles change. Emotions run high. Life gets messy. Are our financial plans and investment portfolios robust enough from a behavioral perspective to cope when that (inevitably) happens?

In my experience the answer is, “Usually not.” For example, we (clients and advisors alike) are always prone to performance chasing – buying what has been working well recently and selling what hasn’t been working and thus buying high and selling low – which inevitably leads to losses when mean reversion sets in and to excess trading generally. “In hot markets, money flows in,” says Professor Ilia Dichev of Emory. “In down markets, people get scared and leave.” As a result, stock investors lagged behind the stock market itself by 1.3 percentage points annually between 1926 and 2002, according to Dichev’s research. Even pension plans and other institutional investors earn an average of at least three percentage points less than the funds they buy. In other words, “past performance is indicative of future beliefs.”

How we might strengthen portfolios so as to withstand the weaknesses of human behavior is thus the enormous challenge this analysis sets out to explore. Continue reading

Birthday Luck

birthday-luckI had been fitfully and uncomfortably sleeping, dreaming of a small dog licking my leg and stealing my snack. I awoke to find an escaped boxer with a cute face avoiding my eyes and licking her lips. Once the flight attendant found her rightful owner, who was not nearly as embarrassed as she should have been, I reassess my situation.

I’m still more than an hour behind schedule and said to be losing even more ground on account of intense headwinds. I’m still scrunched into a long metal tube with the seat-back in front of me compressing my kneecaps into my hips while hurtling cross-country, still several hours from arrival home in San Diego. I’m tired from lots of planes and being away from home for too long. I’m not in the most conducive spot I can imagine for counting my blessings.

But count them I shall, as part of this birthday reflection. “Birthday luck” describes a nuclear explosion of luck that is supposed to happen inside you on that day, giving you the ability to do anything. I don’t really have birthday luck, of course, but my luck is so good that it’s hard to tell the difference.

We are self-serving creatures to the core, of course, and self-serving bias is our ongoing tendency to attribute our successes to skill and our failures to very bad luck. Being an early investor in tech stocks was really smart while being long and wrong in 2001 was really unfortunate. But the reality is that luck (and, if you have a spiritual bent, grace) plays an enormous role in our lives – both good and bad – just as luck plays an enormous role in many specific endeavors, from investing to poker to winning a Nobel Prize. In fact, if we’re honest, we’ll recognize that many of the best things in our lives required absolutely nothing of us and what we count as our greatest successes usually require great skill and even more luck.

That my birth, which I celebrate tomorrow, was into a loving and stable family that valued education and industry was not my doing. That I was born into a land of freedom and opportunity that would allow and even provide the means for a child of working class parents with just one high school diploma between them to pursue and secure a world-class education was not my doing. I merely had to provide sufficient effort. That I was blessed with some ability and interest in a field that provides a good living and constant stimulation was not my doing. I merely had to provide sufficient industry. That I have a boss who supports and encourages me in work I love is not my doing. That I married extremely well and have three terrific and productive children who have also married extremely well is only partly my doing (and surely less my doing than I’d like to think). The wonder of delightful grandchildren is grace personified.

I could have been born in the 7th Century. I could have been born in North Korea. I could have been born into a family that abused me. I could have had to struggle for even minor educational advancement. My boss could be a jerk. My children could be disdainful. My wife could be a little less wonderful (though I doubt it). My grandchildren might never visit. As the great Frederick Buechner puts it, “all moments are key moments and life itself is grace.”

So truly – happy birthday to me. For much of it – verily, for most of what’s happy about it – I have luck (and grace) to thank.

__________

This post initially ran on October 14, 2013.