Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
A copy of Tom’s ebook, Letters to a Young Analyst, can be downloaded here.
In late 2010, I published a series of letters to someone who was about to enter the investment industry. In March of this year, they became the foundation for an ebook, Letters to a Young Analyst, which includes advice and resources for aspiring investment professionals.
Despite the title, the book is not exclusively for a narrow slice of those professionals. I addressed that question in the introduction: “An analyst, then, is simply someone who analyzes, who examines an investment problem with a critical eye. Viewed in that way, the general principles in this book apply broadly to a wide variety of roles.”
Advisors and their firms will find the book of interest for a number of reasons:
- Growing advisory firms face important choices about how to structure and staff the investment function. Learning more about investment decision-making processes is an essential part of making informed choices on how to proceed.
- Those members of a firm who specialize in investments should spend a good deal of time focusing on methods, and the firm should have a training plan for them that is geared toward generating differential analyses over time rather than the same approach used by other firms.
- The investment industry faces a number of challenges going forward (and therefore opportunities as well). The book touches on many of them, including the conflicts between the business models of firms and the needs of clients, the disjointed pursuit of relative performance in the face of absolute client goals, and destructive industry practices.
- Advisors and advisory firms often don’t have great visibility into the workings of other kinds of investment organizations, including research firms and asset managers. Advisors improve their chances of making good decisions about using the products and analyses of others by learning about those organizations and their people more deeply.
It is this last point that I’ll explore more fully here. True understanding of an asset management organization, for example, is difficult to come by, as I wrote in a 2009 piece for
Advisor Perspectives,
Due Diligence from a Distance. Therefore, it’s important to build a base of knowledge about how investment decisions are made in those firms, so that you know the questions to ask and you have the opportunity for a more fully-formed diagnosis of the issues at play. Those goals remain elusive for most advisory firms.
Letters to a Young Analyst helps to provide that type of perspective, as indicated in the review of it by Pat Allen, A Must-Read Book for Fund Company Marketers. Allen says, “Marketing barely rates a mention in [the book], and that’s the point. Curious marketers excel by learning more about everything else, including – and maybe especially – thinking beyond what’s happening in marketing and beyond your firm’s walls. . . . Taken all together, [the book] provides a grounding for marketers who aren’t trained in investment analysis. It's Inside Investing for those who work on a different floor than the Investments team.”
The same principle applies for advisors. Given that most of your interactions with investment firms are carefully scripted (speaking of marketing), it’s important to be able to break through the narratives that come your way.
The book is divided into four parts. The first includes the original letters, followed by advice and commentary on a variety of issues from more than a dozen industry veterans. A new letter from me is next, and then an extensive compilation of resources, including books, periodicals, websites, Twitter feeds, and more. (There are well over a hundred links in the book. An ongoing quarterly newsletter for purchasers will include fresh content of value.)
It is hard to judge the culture of an organization from the outside (as is evidenced by the recent tumult at PIMCO), but that culture will have a great impact on the probability of long-term success. When a firm goes “off kilter” (most often from “a change in leadership or ownership”), investment decision making usually does too. Most observers usually don’t know until after the fact when the organizational conversation has broken down.
There are lots of things that can distort the investment process that appears so well-ordered and logical in marketing materials. Incentives play a significant role, of course, and the relative-performance game – which is a defining feature of this business of herding that we are in – can cause changes in behavior whether the decision makers are leading the pack, lagging it, or just trying to stay in the middle.
Far too often, “career risk trumps investment risk in decision making.” There are principal-agent problems and misalignment of interests to identify and judge. Organizations are torn between their own self-interests and those of their clients, but there are less conscious effects on behavior that may not be as evident.
You can see the emphasis on behavior throughout the book – the behavior of individuals and of the behavior of organizations. Several of the contributors provide windows on the decision traps that lurk. Jeanne Murphy talks about the opposite tendencies of insufficient quantitative analysis and over-reliance on quantitative analysis, each of which is prevalent. She also looks at the effects of complexity, certainly an issue in the advisory world today given the explosion of “alternative” products.
Bob Seawright provides a great overview of behavioral problems that face investment decision makers and gives a number of specific processes that can help to mitigate the “foibles that beset us.” Someone analyzing the investment process of an organization could start with simple inquiries about whether the practices on Seawright’s list are routine or foreign to the firm. (You’d likely be surprised at the answers you’d get.)
A short, straightforward list from Aswath Damodaran is a great example of the effect of getting insight from people with different backgrounds. Damodaran is the leading expert on valuation, an academic rather than a practitioner. Each item he offers is accompanied by just a few words of explanation, but the items themselves are the outlines of an essential roadmap: “Don’t mistake luck for skill. Experience means little. Respect the market. Pay heed to first principles. To thine own self be true.” As I think about how individuals and their organizations struggle to perform, a large percentage of their errors can be assigned to one or more of those simple categories.
Sorting what is known from what is unknown is an important skill for anyone making investment decisions. Yet, it’s easy to become infatuated with experts or star performers. Just think about how much prognostication there is in our business – and how often so few hard facts are involved in decision making. Investment professionals are quick to speculate about the future and reluctant to say they don’t know. “Yet, there’s a lot we don’t know – and one of the great industry sins is a failure to admit that out loud. (It doesn’t sell very well.)”
Much of what is accepted theory today may not be in the investment canon tomorrow. And normal practice and conventional wisdom change with the times. Therefore, it’s important to peel back the layers, to identify and evaluate underlying assumptions and to assess the “how” of investment decision making, as opposed to relying on the transitory predictions, current exposures, or the performance of recent times (which is the de facto way that a very high percentage of investments are selected).
Letters to a Young Analyst isn’t a how-to manual. It offers a view of the challenges and concerns (and analytical rewards) that guide those who provide you with advice and who manage the assets entrusted to you. Understanding them is likely much more important than you realize.
A copy of Tom’s ebook, Letters to a Young Analyst, can be downloaded here.
Tom Brakke, CFA, is a consultant to advisory firms and other investment organizations, helping them to create investment decision making processes that reflect their unique beliefs and circumstances. More information and extensive writings about the workings of the investment world are available on Tom's website.
Read more articles by Tom Brakke
