Data Picks Investments, Stories Sell Them
How investment products are created and sold now is the reverse of two decades ago.
Bloomberg, January 11, 2019.
Once upon a time, portfolios were constructed via storytelling. Once built, they were marketed via data.
That was then. Our understanding of how returns are generated, human tendencies towards error, and decision-making under uncertainty has grown exponentially since. This new knowledge has changed the ways we assemble, manage and market investments.
Now, portfolios are carefully constructed via data. Once created, they are marketed via narrative story telling.
Some of you may doubt this reversal of creation and marketing. Perhaps a little “compare and contrast” might persuade you. If you started in the industry before the dotcoms imploded, you have surely heard some variation of what follows – and not ironically – in that decade or the next:
“We like this company’s competitive advantages”
“Revenue & earnings growth can surprise to the upside”
“We love the way the company is executing on its business plan”
“The firm is gaining market share at the expense of the competition”
“One of the most innovative companies we have ever seen”
“Conference Call/Press Releases/Analyst Report really impressed me”
“Their product pipeline is second to none.”
And my all-time favorite:
“The quality of the company’s management is top notch”
None of these statements is data dependent; each is a narrative. They imply a broader story, ostensibly filled with unique insight into the future performance of a company, and more importantly, its stock. If only you understand the described story as it unfolds, you could use this to your advantage when making stock selection decisions. Theoretically, anyway.1
This may appear quaint to readers of a younger generation, but this is quite literally 2 how most professionals used to select stocks for mutual funds, which retail investors would buy, paying a stiff annual management fee for the privilege.
I hear rumors there are funds that still operate this way. It’s a squishy, imprecise approach, more art than science. Most people – other than a very small handful – are not very good at it. The problem for investors is one cannot identify these outliers until after they outperform. By then, it’s too late.
And the marketing back then? Ironically, it was mostly driven by numbers: the fund’s decile performance rankings; total net (price plus dividend) return to investors; Lipper (now part of Reuters) scores, ValueLine measures, Morningstar ratings. It all kinda looked like a mathematically sound basis for making fund selection decisions. Kinda.
Numerous print magazines – Money, Barron’s, Kiplingers, Smart Money, Fortune, Value Line, Forbes, US News – would create annual lists of mutual funds to own. These funds over here did so well last year that you want to own them next year. That they did this using past performance despite Wall Street’s insistent disclosure one should not is worthy of a future column. Thank goodness we eventually discovered the concept of mean reversion so as to stop making decisions on the basis of past performance.
All of this was fodder for the mutual fund families to use in their marketing and advertising. There was nothing nefarious or purposefully misleading about this, it was simply how it was done in the 1980s and 90s.
That was then, this is now. The world has changed since investors were counting cars in parking lots. 3 Portfolios today are assembled via math and marketed via story telling.
They are still counting, only they have moved towards a more quantitative approach, and less of an intuitive art when assembling portfolios. Consider the major investment trends over the past two decades: indexing, the rise of quants, factor based-investing, smart beta, etc. These are primarily driven by math. Even Socially Responsible and/or ESG (Environmental, social and corporate) investing, which is so heavily dependent upon narrative, is more easily and cheaply constructed these days via computer driven mathematics. 4
Dave Nadig, managing director and ETF expert at CBOE (he runs their ETF.com site), notes that “the active vs. passive ‘debate’ is really just this tension between narrative and data playing out. Passive, indexed strategies are all just math, so marketing folks have to create stories to drum up interest. Sometimes that narrative is just something unrelated to the actual investment.” 5
This distinction is easy to overlook. Consider indexing, which over any 10-year period beats almost every other approach after fees, needs a tale to interest investors. When I write about how emotional investors can be, how their cognitive errors lead to mistakes, how biases like over optimism or home country or politics impacts performance, I am really constructing a narrative. I cannot simply say you should by an index and leave it the hell alone; however, I can create a story which makes it clear to readers why doing something else will likely lead to a worse outcome.
Today, we may be complacent, taking the wisdom we have gleaned from behavioral economics for granted. Remember, Danny Kahneman did not win the Nobel Memorial Prize in Economic Sciences for the pioneering work he (and Amos Tversky) did until 2002; it was not until sometime later that investors more broadly accepted their findings on human errors.
We use stories to discuss how we should be investing our capital, compelling narratives that are both interesting and persuasive. If only because the probabilities and statistics that inform us about future expected returns are likely bore most of us, even if the outcome is better.
1. My favorite version of the narrative basis for stock selection was Iomega, a small disc drive maker that was going to revolution the storage and PC industries.[i] The best part of the story was how people who lived near the company factory in Roy, Utah, would do drive-bys to see how crowded the employee parking lot was on weekends. If it was full, the company was obviously running double shifts to meet demand! Here comes a ton of future profits!
A newish website called the “Motley Fool” was a big enthusiast of the company. If you are old enough, you might remember the early days of the message boards. Speculators freely shared intel about their favorite companies.
Only, as it turned out, not so much. It was instead narrative story-telling, filled with all of the usual wishful thinking and bias inherent to the genre.[i] Herb Greenberg, an early skeptic of the company, recognized the deeper problems with the tale. Writing in Fortune, “Wrath of the Iomegans” he astutely observed the narrative tale was “also the story of the Internet, and how it’s changing the way individual investors are exchanging ideas and linking up to get the upper hand on institutions.”
2. Younger readers will note this is how you properly use the word “literally.”
3. See footnote i.
4. The early days of Green or Socially Responsible Funds were expensive narrative tales. Scorings and quantitative rankings make ESG funds today much more data driven , and much cheaper today.
5. Nadig adds: “Part of the appeal of several recent asset management trends, for example, has been precisely that they gave wholesalers and advisors and marketing folks a story they could tell, often a human story, even though the underlying are pure math . . . I think this may actually be part of a broader paradigm shift too: as society has gotten access to infinite data, raw, factless narratives increasingly take over.”