Following Investment Advice: Part I

Following Investment Advice: Part I

Dear Friends,

I am republishing some old pieces from my days at RealMoney during this busy time that I am in.  If there are significant changes in my opinion since it was first published, I will spell out the changes.  As for this series, there are none.

Originally published 3/24/2004

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Investment Advice


You have to trust your investment adviser.

Look closely at the track record, too.

You want realistic advice you can use.


Advice bombards all investors. Some is good, some is bad, and much of it is indifferent. In this three-part column, I’ll show how to use the advice you receive so you can be a more effective investor. In analyzing any advice, investors have to consider the adviser, personal character issues, and the nature of the investment proposed. In Part 1 today, I’ll focus on the adviser.

Sought-After Qualities

The first issue is always one of trust: Do you trust the competence and business ethics of the adviser? No one is perfect, but has the adviser made sound decisions in the past in areas similar to where the adviser is proposing advice now? What’s the adviser’s track record? If he’s a professional, does he have a clean record with the regulators and his current and past clients?

Even if the adviser has a great track record, did he get it accidentally? In a past job, I had the fun of interviewing a large number of money managers. We had a need for a large-cap growth manager, and our manager adviser brought in a manager who had a stellar, though short, track record.

The principal of the growth manager was a former pro athlete who had developed an entirely quantitative, momentum-driven management method. The presentation was short, and I asked a few questions about earnings quality and how the process might do in nongrowth-driven markets. I received a very terse set of “we can do no wrong” answers.

After the presentation ended, I pointed out three companies in their portfolio that I knew had weak earnings quality. They politely blew me off. I wasn’t impressed with their processes, and my colleagues were not impressed with their demeanor. Then I had my accident; the next week, two of the companies I pointed out blew up. Their accident followed soon after, which was a significant loss of assets under management. The accident of their prior performance evaporated. Persistent good performance happens for the reasons that the adviser specifies in advance, not by accident.

Even if the advice giver is competent and ethical, what incentives does he have in the situation? Full disclosure allows you to decide whether the adviser’s judgment might be shaded by other concerns. Then you can take that into account in making your decision.

Is the adviser cocky? In my experience, pride goes before a fall. One way to measure this is to see whether the adviser admits to errors. The best advisers admit fallibility, and even try to reduce your expectations. You want realistic advice from someone you can trust. Big claims may draw some clients in the short run, but in the long run, clients are kept through dependability.

Next time, in Part 2, I’ll examine how your character affects how you evaluate the investment advice you get.

By David Merkel, CFA of Aleph Blog

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

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