Why investment analysts fail to outperform – A step by step guide to institutional underperformance

Why investment analysts fail to outperform – A step by step guide to institutional underperformance.

Initial comment:

In Berkshire Hathaways annual meetings Charlie Munger referred to a concept called inversion – rather than asking, “How do I achieve success?” he would ask, “What are all the things that would guarantee failure?” His strategy was simply to avoid these mistakes.

Keeping this in mind – the following text aim to explain how and why investment analyst underperform – it does not directly answer the mistakes the average investor makes, because the text assumes an investment funds perspective. In hindsight, this would have been a more relevant article.

A step by step guide to institutional underperformance.

Step 1. Become institutionalised

Rely on flawed models like GGM, CAPM or APT – while forgetting business fundamentals. Alternatively – predict the macroeconomic environment down to the decimal, but still importantly always forget business fundamentals.

Step 2: Nepotism is key

Skills or track records – does not matter – what matters is that your rich family can reference you. Alternatively, get referenced by a friend. If neither is an option, you ought to get lucky – because there are finance bros and macro economist with better grades than you.

Step 3: Become complacent

You have now gotten your job. Here it is important – stop improving. Rely on fellow analysts predictions – and speedrun your due diligence. After all – your worldview is correct and your holistic godlike predictions must outperform. This leads us to the next step.

Step 4: You are not biased or flawed in any way

4.1 We have already established your godlike presence.
(The Dunning-Kruger Effect).

4.2 Always ignore contradictory evidence
(Confirmation Bias).

4.3 You have made your decision, do not change your opinion (Anchoring Bias).

4.4 You may have lost money and time researching – I REPEAT – DO NOT CHANGE YOUR MIND (Sunk Cost Fallacy).

4.5 Your fellow investment analysts price target are way above your initial assumptions – of course you are wrong – change your assumptions to match the almighty group (Group Bias).

If you really want to generate alpha underperformance – there are loads of other biases to rely on, such as: Availability Heuristic, Hindsight Bias, Negativity Bias, Halo Effect: Automation Bias and historical/representation Bias.

Step 5: Fees

Just – always take high fees. This is an almost guaranteed way to underperform (most of your coworkers actually outperform before fees – you can do better!). Also, remember, high fees = high skills.

Step 6: Diworseify

Never let a high-conviction idea ruin a perfectly mediocre portfolio. Once you find a great investment, immediately dilute it with 50 terrible ones to “manage risk.” After all, if you drastically underperform the index, you get fired. You are even obligated to by law.

Final comment

Not all investment analysts seek to outperform the market – investing is not always about making the maximum amount of money – but in many cases its about preserving wealth.

A point I think is sadly overlooked in these “randomly throwing darts and outperform investment funds” articles.

Also keep in mind – everyone will make some of these “mistakes” – and no step will alone lead to underperformance. It is the sum of these steps, that likely – by average – lead to underperformance.