If there is a silver lining to this crisis, it is that most of the investment scams for the past two decades have now been exposed and the search to find solid investment guidance has genuinely become easier. The dirty secret of Wall Street and many commercial investment firms was that their hiring processes were never about hiring the most talented people that truly understood stock markets and macroeconomic trends. Instead, their hiring processes were more about identifying psychological profiles that would produce the best salesmen and saleswomen. The industry’s endless TV and magazine advertisements that revolved around messages of trust and records of operational longevity, in the end, only meant that they were able to perpetuate their scams for several decades longer than the now infamous Bernard Madoff Ponzi scheme. But for the firms that have survived, you can be assured that they will not give up the scams that they’ve perfected for the last several decades. So how can you use this crisis to your advantage to find the few honest investment firms out there?
In the book F.I.A.S.C.O, an expose ´ about the failure of Wall Street to serve their clients responsibly, author Frank Partnoy described the interview process for a highly sought-after position in Morgan Stanley’s asset management group. According to Partnoy, the Morgan Stanley executive that won the job told him that a key question in his interview process was the following: “What are the most important qualities a salesman can have?” The executive relayed to Partnoy that he clinched the job by answering, “Without a doubt, integrity. This is a trust business, and we are selling our trust.” I have always maintained that most successful investment professionals employed by large commercial investment firms would be extremely successful in any sales position, whether that position was in the pharmaceutical, automotive, or retail industry. Given the scandals that have rocked nearly every single commercial investment firm around the world, trust is now a very hard sell in the investment industry. Still, the most successful investment professionals have always been consummate salespersons, and they still know exactly how to psychologically manipulate you to gain your trust. And this is where the crisis can help you identify whether or not an investment professional is deserving of your trust.
Over the years, many different studies regarding stock market performance among investment professionals have come to the same conclusion — that top investment professionals employed by the commercial investment industry are barely likely to perform better than random stock picking. Among the most well-known of these studies was a series of studies performed by the Wall Street Journal in which Journal staffers were instructed to choose stocks by flinging darts at stock table pasted to a board. In late 1998, the WSJ printed the results of 100 of these dart-throwing contests. The professionals won 61% of the time, but still lost an embarrassing 39% of the time to stocks selected by random dart throwing. Against the Dow Jones Industrial index, the professionals’ winning percentage plummeted from 61% to 51%, meaning that half the time the index beat the professionals and half the time, the professionals won. Thus, an investor that merely bought an index fund would have performed nearly as well as every investment professional that partook in the study, and without having to pay any management fees.
Since then, many academics have attributed the near equivalent performance of investment professionals and major market indexes to the efficient market hypothesis (EMH) that states that no investor can earn abnormal returns by trading in securities markets because all security prices reflect all available information. This is utter nonsense. Investment professionals rarely outperform market indexes not because of the EMH but because of the GMH, the Greedy Market Hypothesis. Investment professionals employed at commercial investment firms all over the world generally have one job — to bring assets into the firm, NOT to produce stellar returns for clients. Since their primary job is to convince potential clients to hand their money over to the firm, as odd as this may sound, investment professionals rarely know a lot about investing. They know a lot about how to present themselves to appear to know a lot about investing, and even more about superior sales tactics, but not a lot about investing.
On the contrary, if an investment professional’s primary job was to maximize portfolio returns, then top investment professionals would most likely significantly outperform the returns of major indexes in their respective countries. If you have wondered in the past why the performance of many investment professionals mimics the performance of your domestic stock market index year after year, it is because they employ the terrible diversification sales strategy (versus a legitimate investment strategy) to manage your portfolio. As a consequence of this emphasis on selling versus returns, if you’ve parked your money with a commercial investment firm, you are likely to own every single major component of the stock market index in your country. This is the scam of diversification — you will own almost exactly the same stocks that comprise the major stock market indexes. Furthermore, during terrible global markets such as the ones we have recently experienced, you will be paying management fees for the gift of achieving the same returns as an index fund.
Poor global markets do one thing well. They expose all the flaws and ugly scams, including diversification, that investment professionals employ to gain your trust and your money. All the strengths of salesmen masquerading as investment professionals that are glorified during bull markets are readily exposed as weaknesses during terrible markets. Be warned that this doesn’t mean that their sales skills will diminish, as surely many of the best salesmen will rack up well-constructed but fallacious arguments to convince you that market bottoms have formed when indeed they have not. However, if you fall victim to their same sales ploys after reading this article, no matter how expert their sales tactics may be, you have no one to blame but yourself this time around. Why? This crisis has made it easy to spot the frauds.
Just because an industry has spent billions of dollars on marketing a strategy over a period of many decades does not make it a wise strategy. Instead of clinging to a false belief that has only benefited commercial investment firms for decades and never the average investor, every investor should be using this opportunity to challenge and investigate the validity of past investment beliefs propagated by the industry. Though the commercial investment industry has propagated a lot of lies over the past few years, I maintain that diversification is still the biggest lie that the greatest majority of investors refuse to acknowledge. If you are one such person, let me use history to help you shed yourself of this lie. Throughout the course of history, many “incontrovertible truths” have been proven to be lies after long periods of time when millions of people fiercely clung to such lies as truth.
For example, because of oppression by certain authorities of the Catholic Church that occurred hundreds of years ago, millions of people fiercely clung to the erroneous conviction that the sun revolved around the earth, even though the astronomer Copernicus had already documented many compelling reasons that invalidated this “truth” by 1514. In fact, more than 100 years later, this false belief still persisted among the masses, and when the astronomer Galileo agreed with Copernicus, the Catholic church, under orders from Pope Paul V, convicted Galileo of heresy and subjected him to house arrest for the rest of his life. The Catholic Church condemned Galileo for supporting an indefensible position that they stated “[was] contrary to the true sense and authority of Holy Scripture”. Of course, this example is just one of the most famous of thousands of false beliefs propagated by men in positions of authority throughout the course of history.
In light of the above historical perspective and the fact that you will not find a single investment professional that significantly outperformed any of the major global stock market indexes over the past two years by employing a diversification strategy, it is time to seriously question the “wisdom” and the true intent of diversification. Why does the commercial investment industry hire its financial consultants from such a far ranging diversity of professions? If you wanted to work for Ogilvy & Mathers as an advertising executive, you would have no chance of being hired unless you had many years of experience in advertising. If you wanted to work for HOK as an architect, you necessarily must possess a degree in architecture. But if you wanted to work for a commercial investment firm as an investment advisor, the most important qualification that you needed to have, bar none, was the ability to sell, not the ability to understand financial markets.
I have always maintained that diversification is a sell-side strategy that commercial investment firms employ to hide the flaws and weaknesses of their salesmen and saleswomen that understand very little about how to identify the macroeconomic trends so important to understand the best ways to invest your money. Diversification theory states that it is impossible to know what asset classes will perform well every year and thus, the reason diversification is necessary. This is a lie. Because of the commercial investment industry’s emphasis in their hiring and training processes in the ability of their employees to sell, it may be impossible for THEIR investment consultants to know what asset classes will outperform this year; however this does not mean that it is impossible for ANY investment consultant to know what sectors will outperform this year.
On August 14, 2006, to prepare investors for this developing crisis, I wrote an article called “The Days of Buy and Hold are Over”, in which I stated: “Unless your name is Warren Buffet, the days of buy and hold are over. Actually even if your name is Warren Buffet, the days of buy and hold are over. At least they are for the rest of this decade. Buy and hold as a strategy is dead and will get you nowhere for the second half of this decade.” Just in case investors did not understand my message completely, I followed-up this article with a more explicit message just two days later on August 16, of 2006, in which I discussed the fact that the S&P 500 in mid-2006 stood at the same level it did 7 & 1/2 years prior on January 1, 1999. Regarding this situation back then, I stated : “And that’s the good news. The bad news is, as of 2006, the U.S. stock market’s performance will likely become even worse for the rest of this decade.” I was so adamant about these views back then because for anyone willing to seek the truth, the fact that an imminent crisis was brewing was crystal clear and indisputable. As I said, diversification is a total cop-out but a fine strategy best reserved for salesmen that understand nothing about macroeconomics. And this brings me to my last and final point.
Today, trust still probably ranks as the number one most important quality for choosing an investment consultant. Poor markets, ironically, make this task infinitely easier. For those investment consultants that are asking for your trust today, just seek out their track record of performance for the past two years. If they have significantly outperformed the global market indexes during this time, it is very likely that you can trust them as obviously they have executed some markedly different strategies from the rest of the crowd to achieve their returns. If they have performed in line with the general poor performance of the global market indexes – adding gains when the global markets experience a bear-market rally, and losing value when the indexes tank – you almost certainly need to keep searching for someone you can trust.
Many investment firms apply not only the terrible theory of diversification to their portfolio management strategies but also to the analysis they disseminate. In other words, when global market indexes experience a bounce, they employ one analyst that writes a publication stating that this is merely a bear market rally, while another one of their employed analysts writes an article that this event marks the beginning of a new bull market. When oil is trading near $50 a barrel, they employ one analyst that states oil is heading to $80 a barrel while another one of their analysts states that oil is heading to $30 a barrel. Or, if they have analysts that make 10 wrong calls in a row and then make one correct call, they extol the virtues of this one correct call while conveniently burying the grave errors of their prior 10 predictions. Of course, investment firms that employ the above strategies will appear to be correct all the time, but a simple check of their track record should reveal them as either fraudulent or trustworthy.
Given the accessibility to a firm’s track record granted by the internet, checking a firm’s track record during the last two years should be fairly easy. Review their performance track record through their blogs and publicly posted information. Since many firms will delete their erroneous predictions on their own website, Google the firm’s name and see if you can find other websites that re-published their past predictions. Review emails a firm may have sent you during the past two years since you now have the benefit of hindsight to determine if the majority of their predictions have been excellent or plain rubbish. Taking these few simple steps should allow you to uncover a clear and unbiased record any firm’s track record. In the end, if you can’t find any public information that allows you to establish or verify an investment firm’s track record, than this type of discovery should raise a serious red flag.
During a bull market, you may not know who to trust as everyone looks like a genius, but during terrible markets, when very few perform well, finding an investment firm you can trust should become infinitely easier. Just follow the tips above and finding a trustworthy firm to inform you about the best ways to invest money during this crisis should become a cinch! And what analysts should you trust in the future? To avoid the Machiavellian professionals that are using this crisis for self-promotion, simply identify the small group of analysts that posted warnings of this crisis months and years before it happened. Any analyst that understands that the fraudulent monetary system implemented by Central Banks is the true root of this crisis would have been able to see this crisis coming for a very long time now.