For Investment Managers A Sour Outlook Is Good For Business (Development)

Little Funny girl keeps lemons

It is not unusual with the proliferation of investment newsletters, updates, and blogs to have a client forward a piece and ask our opinion on someone else’s opinion. We do not resent it; we welcome it. It is an excellent opportunity to explore new ideas, outlooks, and occasionally some bit of information that has yet to cross our desk. More importantly, however, it is an opportunity to revisit our foundational principals, our long-term allocations, and our tolerance for risk. We believe those conversations, specifically, are among the important that can be had between advisor and client.

Considering the different perspectives across the different sources that come our way there is an unmistakable pattern that emerges. Nearly everyone who provides advice and perspective is negative about the future. We acknowledge that our sample size is small and may not accurately reflect the outlook of all published and online advice brokers. However, our objective is not a study of the industry itself, rather a look at some of the reasons individuals should be wary of anyone who suggests the near future is going to be substantially different from the present.

Several years back we published a little piece which touches on some of the more common biases people, including investment managers, are likely to encounter “A Few of Our Favorite Cognitive Biases”. In the piece we identify biases which may act against reason. One may suggest that markets are unreasonable and therefore question the value of reason when applied to markets, however we would like to set that philosophical debate aside for another day. Let us assume that the less we allow biases to influence our decisions the better those decisions will ultimately be.

There are several questions that we believe need asked when it comes to investment updates and their authors. The first of which is, why do we assign them any value at all? One of my favorite advertisements goes something like this “Legendary Investor Who Predicted 2008 Crash Says Do This Now…”. It is perfectly reasonable to expect that someone, in fact lots of people “predicted” the 2008 crash as we will attempt to explain. Even if we give this advertisement the benefit of the doubt and assume that a Legendary individual accurately predicted the crash in the days and weeks leading up to it why would that single bit of information lead us to conclude that their advice has any value thirteen years later? What if that individual had been incorrectly predicting the housing bubble for the 20 years prior? What if that individual has been consistently wrong about the stratospheric rise of the market in the decade after the crash?

One of the first things we learn as investors is “past performance is not indicative of future results”. Yet investors rush into mutual funds with superior historical performance, and businesses with impressive-sounding strategies like “Open Architecture” which offer to replace “underperforming managers” with “out-performing managers”. To us this seems ill-advised and in fact there is no shortage of studies which document how highly rated funds are “no more likely to outperform a given benchmark than lower rated funds”. Even so we acknowledge our own bias against mutual funds and the “manager of manager” approach, so we’ll will move on and concede these approaches can and do work well for some investors. As far as the advertisement, Authority Bias causes us to grant greater credibility to the opinions of those we feel are authorities on a given subject. Is someone an authority because they were right at one point in time thirteen years ago or because we are told they are “Legendary”?

How is it that lots of people predicted the 2008 crash as we suggest when it seemed such a shock to individuals, institutions, and the market itself? The answer can be found in the title of this piece. It’s good business. Consider the insurance industry who exists to protect against risk, or perhaps our peers (Registered Investment Advisory Firms) who sell investment annuities and other insurance-based investment products. Would it make any sense in the attempting to lure investors away from banks, brokerage firms, or pure investment management firms into insurance products to predict the stock market is going to provide superior returns in the future? Why would a prospective client choose to leave their existing relationship if the future looked bright? Generally, the key to motivating a prospective client to abandon their current advisor is not the opportunity for greater returns. It is the promise of avoiding a future calamity their current advisor has not foreseen and prepared to mitigate. So what you need is, of course, an impending calamity. We do not mean to pick on the insurance industry, salespeople across all industries use this strategy. Trade your car before the warranty expires, sell your home before the AC unit dies and so forth.

Let us imagine a slightly different motivation for a moment. What if the investment manager’s motivation was not a short-term and transactional in nature, but rather more long-term? For instance, what if they were motivated not to bring new clients in the door today, but to advance their own notoriety? Granted, increased notoriety amplifies the ability to bring new clients in the door, which is still the goal, but notoriety is the long game. First seek national recognition as an analyst then move into client management. Who shows up on CNBC in the morning suggesting things in the near term really are not going to be substantially different than things are today? Where is the value in that? People that watch CNBC want information that allows them to trade or position their portfolios strategically for the future. They want to find opportunities. What opportunity is there in “smooth sailing for a bit”? No, if you want to get on CNBC you need to say something is mispriced or the future looks different than today and therefore change is required.

The good news for analysts is being “wrong” in your forecasting is no big deal. No one’s perfect so the saying goes. However, if you are right you may become “Legendary” like the individual in my favorite ad. Regardless of motivation investment management authors are incented to predict the future will be different than today. With the market seldom stagnant for long, chances are 50/50 in the future they will be able to say any given prediction was correct. Given enough time and enough predictions one might rack up a very large number of “correct calls” to tout.

As the natural tendency of (stock) markets is to rise over time due to inflation, the authors that suggest the future is bleak are taking the greater risk and are therefore more interesting to us. One of the more famous sourpusses is “Dr. Doom” Nouriel Roubini, “one of the most respected economists on the planet” who in 2018 famously predicted massive recession by 2020 with the Fed forced to raise overnight rates to 3.5% and the strong likelihood Trump would start a war with Iran. Would someone who has consistently been so wrong for so many years be relegated to the dustbin of quack soothsayers? No, he has a cult-like following and enjoys prominent airtime on financial news networks. The reasons? He predicted the 2008 housing bubble and market crash. That is the secret with volatile markets, keep saying the same thing over and over and sooner or later you are right. For a mere $239 a year you can get a fair amount of Mr. Roubini’s current thoughts or pay $875 a year and get expanded access!

Please note, just as there are perpetual doomsayers there are also perpetual optimists. Tom Lee at Fundstrat will forever tell you why Cryptocurrency and stocks are moving higher for $199/month. The problem with Mr. Lee’s model is it is a harder sell emotionally. Consider the news each day. Every institution that we once held in regard is under assault. Intelligent people may disagree on whether the assault is justified, however one would be hard pressed to argue that there is no assault underway. America’s competitors (enemies?) are becoming bolder and more powerful, and America’s unity appears to be waning. In this environment it is much easier to argue things are going to get worse than better. So people tend to extrapolate that “the market” must also be in for hard times.

Confirmation Bias is perhaps the strongest and most prevalent bias that exists when considering “authority”. It is defined by Dictonary.com as “the tendency to process and analyze information in such a way that it supports one’s preexisting ideas and convictions”. If we believe the county’s going “down the tubes” then we tend to prioritize or inflate the worth of talking heads and their opinions which support our belief. We may even dismiss the potential conflict of interest from authors who say the future looks grim although we know that if their goal is separating us from our money that is exactly what they should be saying. We would tend to be skeptical of a sales agent at a Ford dealership who tells us Fords are better than Chevys. In fact, given the make, model and year it may be true. The point is that we expect to hear this and are resistant to believe it (unless we happen to love Fords, then we may nod approvingly) as it would not be in the Ford sales agent’s interest to say anything other. We are not suggesting you dismiss all investment and economic commentary, just as with news the best is when it is strictly informational without editorialization. If the investment piece argues for giving the author money we simply recommend treading carefully.

Here is what we believe. There exists a spectrum of “quality of investment management authors”, from the very good to completely worthless. However, even the very good are only likely to accurately predict the future slightly better than half the time. Better perhaps than a coin flip, but not significantly so over long periods. An individual investor can likely significantly improve their long term returns by rejecting the temptation to make large swings in allocation based upon someone’s opinion, regardless of that someone’s impressive track record. It is better to come to an asset allocation that conforms with your long-term risk tolerance, need for income and/or growth, and objective and settle in. Find a low-expense solution, be it manager or index-approach and revisit your allocation to identify if your needs have changed. If you manager is a Fiduciary (and he or she ought to be) you may grant them a little latitude on allocation to raise or lower cash on an ongoing basis. You may work with that manager to increase exposure to bonds in higher interest rate environments or stocks in lower. You may see opportunities in gold or cryptocurrency or flying cars. Whatever it is there is research that suggests it is prudent to allow for some exposure to the speculative. While we advise caution when considering speculative investments, we advise extra caution when coming across an author who suggests you need to fundamentally change your approach because the end is nigh, or that they have identified the next “Amazon”.

If anyone could actually do that, they would have no need for subscribers at $199 a month.

Finally, bonus points awarded to those of you who thought “here is a piece from an investment shop to its clients arguing to resist the allure of other firms’ efforts to persuade them from moving their money because of a potential conflict of interest, now that’s irony”. We get it, we really do. We hope you appreciate our “all cards on the table” approach to communication, and while potential conflicts of interest may arise as a Fiduciary our duty is to address them and always act in our clients’ interest, not our own.


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