(I’m just going to apologize in advance for the sports analogy. Bear with me).
There was a pretty great piece in the NY Times recently about the “4th Down Bot.” The basic idea here is to take a statistically valid measurement of how NFL coaches should make 4th down decisions to maximize their chances to win games. (For the non-initiated, football teams have four plays aka “downs” to move the ball 10 yards. If successful, the team gets a new four downs.) The study shows that NFL coaches are much too risk-averse, given to punting on fourth down or even kicking a field goal when they would, on average, be much better off going for a first down. A rational approach would say that NFL coaches are simply too dumb for their own good and should be fired for poor decision making.
But there is a behavioral factor at work. Coaches who take risks, even well calculated risks, will be forever second-guessed if any of those risks fall short. It is a much safer career decision for the coach to punt. There aren’t many NFL pundits, owners, and general managers who will berate a coach for punting on Fourth-and-Four in the first half. Punting is the socially acceptable decision, and a coach earning a few million dollars a year isn’t going to buck the trend, even if bucking the trend is the best way to win more games. If you put the Fourth Down Bot dataset in front of an NFL coach, I doubt he would be surprised. These coaches aren’t idiots, they are protecting their careers! They have families and college tuition and retirement accounts and mortgages and they are going to take the optimal path to keep their jobs, even if it means winning fewer games.
Like everything else, this has me thinking about the financial markets and the investment profession. The more I reflect on this, the more I believe most financial advisors are like NFL coaches. They know what the data set proves, but they can’t take the career risk to act on it.
You see, in my experience most investment professionals have built their businesses around a simple theme: give me your money to manage (hopefully for at least a 1% fee!) and I will help you outperform the markets. This story presents itself in manifest ways, mostly in the “we-can-do-it-with-less-risk” pitch. And so these investment pros pick stocks, manage managers, time the market and sell insurance products in the guise of this pitch. I would venture to bet that a decent percentage of these professionals know, on some level, that the pitch is a ruse. You have to have your head, neck, and shoulders in the sand to have not seen the data on the performance of active strategies vs. passive strategies. So as a professional you either believe those odds don’t apply to your personal brilliance (strong probability of that considering the people I have met in this industry) or you shove those numbers under the rug for a simple reason: you and your family need to keep eating.
How does a lifelong investment professional, who has spent his/her career telling clients that s/he has a superior investment strategy suddenly change the tune? It is a tremendous mea culpa and for many a career risk that is not worth taking. Not to mention that to stand up and say “this doesn’t work!” in an environment where most other investment professionals are promising otherwise can cost you opportunities to win new clients. And so, in the interest of putting food on the table, putting Joey and Jamie through college and hopefully retiring themselves, the story stays the same: I Can Beat The Market. To say otherwise, even if true, even if it is the most effective way for clients to invest in the markets, is career suicide.
Further Reading:
TRB: Confessions of an Institutional Investor
Bason Asset Management 