End the “Code of Silence” For Investment Professionals

reminiscences of a stock operator pdf

End the “Code of Silence” by David merkel, CFA of The Aleph Blog

I was asked to contribute to a survey recently, and one question made me think.  It was a question about why don’t more people consult investment professionals, and What keeps them from doing so.  I gave a fairly standard answer for me:

There are two reasons: first, most people don’t have enough income or assets for investment professionals to have value to them. Second, people don’t understand what investment professionals can do for them, which is:

  • They can keep you from panicking or getting greedy

  • They can find ways to reduce your tax burdens

  • They can diversify your assets so that you are less subject to large drawdowns in the value of your assets

After I wrote it, I submitted it for publication, but I wasn’t really happy with my answer.  The thing that left me less than happy are the various tales that I hear where investment advice is subpar, communicated poorly, etc.  Personally, I expect the real reason many people don’t consult investment professionals is fear of a bad experience, which may often stem from a a bad experience that they have had or a friend my have had.

I sympathize with the goals of the CFA Institute’s Future of Finance Initiative.  That said, I think it is a nice-sounding idea that won’t get far.  I have four main reasons why:

  • We don’t have a financial system where all financial professionals have to be under a common ethics code, with additional ethics code sections for areas of specialization.
  • We don’t have a culture among investment professionals that really wants to clean up the system, and talk about abusive practices, such that they become well-known and go away.
  • We don’t have enough of a culture among investment professionals that wants to genuinely educate the investors that want it, and in ways that don’t directly benefit us.
  • Because we don’t have one unified theory of investing, there will be enough gray areas where people will still get hurt by professionals.

On the first point, I would note a recent article of mine on self-regulation financial markets, where I said:

The guy from the National Futures Association emphasized the idea that mandatory membership in the association as a requirement to do business was paramount for an SRO and I can see that.  The SRO then has the “death penalty” hanging over the heads of those they regulate.  That said, consider this: the CFA Institute may dream of the day when all involved in investing *must* hold a CFA Charter.

I have no doubt that this would be a good thing.  Ethics codes are good for the industry, and to kick out bad apples would be a good thing.

On the second point, it would be worthwhile for financial writers and some larger firms to take on common practices that are abusive.  This will be controversial, because not everyone will agree on every item, but even getting a stoplight list where red is bad practices, green is good practices, and yellow means be careful would be a good start.

On the third point, we need to advocate for the best practices even where it doesn’t exactly fit where our businesses make profits.  Think of it this way: it often helps in home repair when someone who comes to fix one thing gives me some free advice on another matter that he doesn’t do, but sees it and tells me.  That builds goodwill for a later date, because I know that person cares about me, and not just what I pay him.

On the last point, my earlier article went over many of the disagreements:

Ethics aren’t neutral; people disagree about what is right and wrong to a high degree.  Even in finance, there are considerable disagreements in what is the correct behavior:

  • Active vs Passive management
  • Value vs Growth
  • Does Technical Analysis work?  (Is there truly a single discipline there?  I don’t think so.)

That’s a considerable reason why it would be difficult to enforce the views of the CFA Institute over the markets.  There is no commonly agreed-upon view of how the markets work.  The views of the academics are ridiculous, and do not reflect market realities. But many asset allocators trust them, even though their results are poor.

But even if this results in some squabbles, at least people can be aware that there are differences of opinion, and maybe that can inform the way we talk to clients.  Long only managers should tell their clients to buckle in, because they do not time the markets.  Traders should tell clients that they won’t do well in choppy markets, and that methods to limit losses and let gains run have their limitations.  Time horizons for investment decisions should be clearly identified, so that investors can set their expectations reasonably.

And that could be the best part of this: if investors have a good idea up front of how an investment will likely perform in a variety of scenarios, there will be fewer negative surprises, and hopefully, happy clients.

Anyway, that’s what I think the goals should be.  Now, who else wants to make them practical, and be willing to speak up about this?



About the Author

David Merkel
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 RealMoney.com. 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.