Never take broker recommendations at face value

Topic: learning about learning in a stock market context

Conclusion: Think through your investment strategy seriously; exactly what is it, that is supposed to make you outperform some of the smartest and most driven people in the world?

The magic formula of outperformance

Do you want to know how to outperform the stock market? Not only that, do you want to know how to both avoid negative years, and outperform the market?

For the benefit of new readers, I was a hedge fund manager for 15 years. Our fund won the to date only HFR reward for “The European Hedge Fund Of The Decade” (2000-2009). Between our inception in October 1999 and our peak in April 2011 the fund returned, net of fees, around 600 per cent to investors while the stock market was flat. With no down years. Our best years were 1999, 2001, 2002 and 2008. In about that order, if I remember correctly.

There exists a concept of an ideal investment method in my mind. I, however, have never been able to follow it. You can read about those Platonesque investment best practices in my TAOS series (and upcoming pamphlet) or in my old (still) give-away e-book.

This article deals with how we in practice used third party research, i.e. brokers, to produce those returns, not what we in theory should have done.

Futuris (the fund) received research reports from around 20 different brokers (Citigroup, JP Morgan, Goldman Sachs, Bear Stearns, Deutsche Bank, Nomura, Morgan Stanley, Merrill Lynch, BNP Paribas, Cheuvreux…, you know the names). Every day a few phone books’ worth of research reports landed on my desk (conveniently, I had people that opened the envelopes for me — during vacation times some of the envelopes remained unopened and went straight to the paper recycling bin).

This is important:

I never took a recommendation at face value.

Many private investors these days buy stocks when their bank or broker issues a buy recommendation. Some might buy just to ride the wave of greater fools buying, but many actually buy just because “an analyst said so”. Some even do it only based on public news, that some random research firm or journalist has put the word “Buy” in print.

What I did was collect and compare the underlying data and reasoning supplied in the reports (as well as in IRL meetings with some of the analysts, and client-only conferences). I wanted to triangulate an asymptotic “truth”, the real world signal that – distorted through management hyperbole, analyst preconceptions, biases, misunderstandings and muddled reasoning – gave rise to the wide range of reports available to me.

I used all this information and my bird’s eye view, to form my own view of a company’s position and development, including its 3-12 month finances, and compared that to my assessment of what the important market players were likely thinking. If the discrepancy were large enough, and if the margin of safety in terms of absolute valuation was palatable I put money to work*.

* Putting money to work in a hedge fund with three partners isn’t all that straight forward, even if Futuris wasn’t big on bureaucracy. Actually, the research part was made as a collaboration effort between me and my in-house analyst (portfolio manager to be, really). Once the idea was more or less fully formed, I pitched it to my two partners, and we discussed whether it was good enough on absolute terms, as well as if it warranted replacing one of the existing forty positions in the fund, i.e., the position’s relative merits).

Perhaps the most important lesson to draw from this post is that a professional investor does not follow broker recommendations, so why should you?

About learning, memory and connecting with reality

Initially I set out to write about how to learn, and not least why to learn. When you hear about a “learning machine”, ask yourself “what for?”. I ask that about God (if he can’t ‘kick back’ as David Deutsch says, what is he good for?). I ask that about the limited number of people I can have a serious relation with (which ones and why: comfort, companionship, learning, challenge…).

A while ago I listened to an episode of The Brain Science Podcast about “affordances” – how the brain perceives objects foremost in terms of what you can do with them = their “affordance”. Today, episode #141 of the same podcast series dealt with a similar idea: “concept neurons” and how our memories are mainly based on a few salient key concepts stored in particular single neurons in the hippocampus. These “concept neurons” are connected to a limited amount of facts stored in the cortex and together they form the basis for a made up narrative that the brain decides makes sense for the moment.

Just as we don’t see the world, we don’t remember it either. The brain makes it all up, and that is why we need notes and commonplaces, and to constantly battle our desire to be right by exposing ourselves to opposing views and as wide a range as possible of “facts”, if we want to be able to kick reality harder than it kicks back.

Talking of kicking back, do you really want to compete in the worst conceivable environment, i.e., the stock market? It features the best and most driven competitors, and the market can be characterized as an ever-changing complex beast, where correlations are tentative at best, not to mention highly variable.

Hmm, it seems I need to expand on these last ideas about memory formation, learning and purpose in a separate post later on.

Conclusion: Does it work?

Just take this with you if nothing else: Why do you learn; what do you want to accomplish and why? Why is it supposed to work; what is your theoretical foundation? How do you learn? Is it working? Are you hitting reality, or does it keep hitting you while you punch holes in the air?



  1. “exactly what is it, that is supposed to make you outperform some of the smartest and most driven people in the world?”

    Food for thought, for sure. Well, how about this — regular people don’t run hedge funds as a competitive business, so we don’t need to care about that. My goal as an investor is to do *well enough* and not suffer a 50% drawdown every 7-10 years. Since I’m not a going concern, that drawdown can be terrible timing, i.e. when an unplanned need may occur or I may not outlive the recovery.

    75% of funds don’t even beat the averages. So a lot these smart/driven professionals are doing a horrible job.

    We must also ask, outperform at what cost? If it’s a full time job, no thanks. If we can grab half the performance while living at the beach…

  2. Great article.

    Your process for stock picking seems a lot like my process for… everything. I suppose a lot of people, faced with an abstracted but consequential decision like investment, would prefer advice, “analysis”, or a rules-based system, to the perfectly effective method they unconsciously use for, say, deciding when to mow the lawn.

    Steve’s comment reminded me of the reason someone told me some years ago about why they invest in stock market – the point is not to beat the market or to make money, but to minimize losses. Stashing fiat money has its own risk, and so does gold. It’s a negative-sum game.

  3. Mycket intressant! “Reasoning from first principles” verkar m.a.o vara lika ovanligt i investeringsvärlden som i dem flesta andra delarna av livet. Får mig att tänka på Feynman och hans förmåga att aldrig acceptera “face value”, utan istället hela tiden sträva efter att utöka sin förståelse av de underliggande principerna.

    Håller verkligen med om vikten av att inte glömma “why:et” i sin inlärning. Har du någon teknik eller taktik för att påminna dig om det i vardagslivet?

    Keep up the great work!

Leave a Reply

Your email address will not be published.