Is guru advice to be trusted? Does the chef eat his own cooking? In most instances it is heartening to see experts practice what they preach. Too often that is not the case.
It is fitting to challenge a financial advisor by asking if he invests in the products that he recommends or endorses. There are both hard and soft interpretations for this common scenario and their likely replies.
In many instances an affirmative reply would considerably increase confidence in the recommendation, and command more mutual trust. However, in other instances, because each investor has his own special objectives, priorities, portfolio plan, and risk tolerances, a negative response is equally acceptable.
Several recent postings highlight the apparent disparity of endorsements with perceived actions. I was motivated to prepare this posting after reading the Forum exchanges on these subjects. More on this matter later.
Searching for a causal-effect relationship between two observed parameters is a respected and an honored scientific research tool. However, it must be applied sensibly; an indispensable constraint is that a logical coupling must exist that reasonably explains why the independent parameter influences the behavior of the dependent parameter. That coupling is a mandatory requirement. When that linkage is distorted or completely abandoned, the output is often Junk Science. There are both good correlations and bad correlations. A solid researcher knows the difference.
Carefully executed Data Mining has contributed significant discoveries that have advanced our investment knowledge base. I have personally developed an attractive correlation between corporate profits and GDP growth rate; that’s an illustration of useful data mining. Data mining need not be a pejorative. Unfortunately, it has also been extensively misdirected to produce meaningless, junk correlations.
All savvy investors are familiar with at least three such egregious examples of data mining misuse. You likely remember the false correlations between butter prices in Bangladesh, between women’s skirt lengths, between Super Bowl outcomes, and the expected return from the S&P 500 Index as a proxy for the equity marketplace. Since only correlations that historically reproduce the data collection period with considerable fidelity are reported, they obviously work – at least for that data period. The issue is, do they remain viable in the future? They work until they stop working. That’s the nature of poorly executed data mining exercises.
A mutual fund learning lesson from a poorly performed data mining study was documented in the James O’Shaughnessy 1996 book titled “What Works on Wall Street”. It was touted as “a guide to the best-performing investment strategies of all time.” The method used a multiple parameter regression modeling of conventional fundamental stock ratios to define a portfolio of anticipated superior performing equity positions.
The book was a huge success and made O’Shaughnessy instantly famous and wealthy. A mutual fund was designed based on the study and sold to the public intending to exploit the study’s findings. In a few years it failed after some minor early successes. The procedure worked until it stopped working.
Recently, a portfolio from vintage FundAlarm archives has been resurrected on this Forum. You may recall that when it was assembled it was called the MMLL portfolio. It was designed to be conservative, with dampened volatility and forgiving response in market downhill periods as its primary attributes. Those are exemplary goals. It does exactly that. Of course, in an expansive marketplace environment, the MMLL portfolio will likely underperform. There are no free lunches.
The portfolio was proposed and constructed by a departed participant from these discussions; he used the sobriquet Fundmentals. I am sure many remember that Fundmental did not invest in the well diversified, multi-holding portfolio that he cobbled together. It includes bond holdings. He made no claims in that direction since he freely posted his own portfolio components. Fundmental’s portfolio was highly focused, often in energy products, and not diversified. His personal portfolio properly reflected his investment style. By nature, he believed in a momentum investing philosophy, and applied a sector rotation strategy as an implementation tool. That’s okay because that’s a representation of his investment profile.
He constructed this more diversified portfolio as a service to Forum members. At the time of its construction it was based solely on a careful review of recent, past mutual fund performance. He exclusively used a rearview mirror approach when assembling the portfolio. He correctly postulated that the diversification would provide protection during an equity market meltdown.
From Fundmental’s perspective, it was a paper exercise. He did not eat that portion of his cooking. If you trust his investment acumen and research diligence, you might consider investing in his MMLL portfolio; but remember that he did not have a pony in that race. As always, the individual investor must make his own decisions in his quiet deliberations. Fundmental was serving as a financial advisor who did not eat his own cooking in that capacity. Personally, I am not alarmed by that observation.
A second minor eruption has emerged from a fund review that David Snowball published many months ago. The posting analyzed the merits and shortcomings of the Nakoma Absolute Return Fund (NARFX). Some Forum members interpreted his summary as an endorsement of the fund. It is not; it is simply for informational purposes.
The report is a very detailed and an attractive fund review. I certainly understand why some Forum participants glommed onto NARFX. Unluckily, it has generated disappointing returns; too bad, but those are the risks and uncertainties that exist for all investment products, especially glitzy ones.
Surely no member of this Forum imagines that Professor Snowball commits resources to all the mutual funds that he assesses in a positive way. I do not recall David ever stating or even implying that he owned NARFX. If he did follow that nutty policy, his portfolio would be hopelessly distorted with scores of highly correlated holdings. That’s not a portfolio grounded in firm diversification principles. That’s not what Professor Snowball is about.
When making a personal portfolio selection, I am convinced that David uses a sharp scalpel, and not a hatchet. Again, if you choose to buy a fund based on a favorable Forum review that it your prerogative. The factoid that David does not eat his own cooking in this instance should not sway you one way or the other; it does not matter whatsoever. He is providing data in an appealing format that allows Forum members to make more informed decisions. You judge if he has an iron in the fire. I don’t think it matters.
As investors we must always be alert and be skeptical of all investment advice. In many financial circles the term “guru” is a polite substitute for the word “charlatan”. Peter Drucker was one such individual who made that connection. So care must always be exercised. Much of what is reported, what is spoken, and even what is written is simply hogwash.. It has no gravitas to anchor it.
Investment advice is frequently faddish-driven. At various times, buy-and-hold, sector rotational, or momentum tactics are the Lion Kings of portfolio management strategies. The current favorite fad changes with shifting investment winds, usually reflecting what worked in the most recent past. One thing is certain; it will change again – and soon.
As an independent investor responsible for your own successes and shortfalls, a huge dose of skepticism is always a prudent quality. A charlatan will always present an outstanding record. That record has been prepared by a disingenuous selection of facts, or a judicious choice of timeframe, or is totally a fake. Good research must dig deeper to expose the actual, not merely the claimed, data sets. Also prudence demands that a judgment must be made of the purveyor’s character, motives, and honesty. Trust in the messenger is mandatory.
The cautionary warning is simply this: Don’t fall victim to the mad ranting of an unscrupulous profit seeking guru. They are masters to their goals first, yours are a distant and unhappy secondary consideration. The good news is that separating the good and the ugly investment gurus demands the same skill set that is needed to assess candidate active mutual fund managers. We have considerable experience with that task.
What do you think?