of an Investor
Blaine Lourd got rich picking stocks. But then he realized that everything
he thought he knew about the markets was wrong. And he's not alone.
This is the illustration which Portfolio Magazine used for the Michael
Like a lot of
people who end up on Wall Street, Blaine Lourd just sort of stumbled in. He'd
grown up happy in New Iberia, Louisiana. His father had made a pile of money
in the oil patch, and Blaine assumed that he too would one day eat four-hour
lunches at the Petroleum Club, hunt ducks on the weekends, and get rich. His
older brother, Bryan, had left Louisiana to make what seemed like a quixotic
bid to become a Hollywood agent, but Bryan was gay, even if he pretended not
to be. (He's now a partner at Hollywood's Creative Artists Agency.) Blaine
was distinctly not gay and felt right at home in Louisianaright up to
the moment when, during his third year at Louisiana State University, the
price of oil collapsed and took the family business with it. That was when
he realized he had no idea what he would do with his life. His chief distinction
at L.S.U. was his ascent to the post of social chairman at the Theta Xi fraternity,
and while that was nothing to sneeze at, he didnt see how it qualified
him to do anything else. His father, after informing him that there was no
longer a family business for him to inherit, suggested that his ability to
get people to like him might go far on Wall Street. That's what first got
Blaine thinking. "I didnt know what Wall Street was," he says.
"I didnt even know where Wall Street was."
Really, he just
wanted to be a success. How that happened, he didn't much care. So in 1987,
at the peak of the bull market, he landed a job with investment firm E.F.
Hutton in Los Angeles. A few weeks into Blaine's training program, E.F. Hutton
collapsed following a check-kiting scandal and was sold to Shearson Lehman.
Blaines training at Lehman consisted of a monthlong class, which focused
mainly on overcoming customers' objections, and a close reading of the bible
on how to peddle stocks to people you've never met: Successful Telephone Selling
in the '80s, co-written by a Lehman managing director named Martin Shafiroff.
presentation creates a sense of urgency. If the prospect fails to act now,
he will risk a loss of some sort.
Speak with confidence
The most important
part of the presentation is the close.
Blaine set a
goal for himself: Reach 100 people a day by telephone. Half the time, people
hung up on him, but about one in every 300 calls led to a sale. He arrived
at his office at 6 every morning to make sure he got the best lead cards.
Even at that hour, the place was loud and frantic. Traders' hoots and hollers
screamed the firms need to move a specific block of stock; the TV on
the wall blared potentially market-moving news. He was paid on commission
and driven by fear of failure. "There were a lot better salesmen than
me," he says. "I just worked harder. I made more calls. And if you
make more calls, you will get the sales. And it doesnt matter what you
say." Most of the time, he just read from the same script as the other
brokers: "Are you familiar with Warren Buffett? We have information from
our sources on the Street that his next position is going to be in a company
much like Cadbury Schweppes. [Pause] I know youre busy, but I'd like
to call you once or twice in the next six months when we have a substantial
idea that will make you three to 10 times your money."
would call back 10 days later, it almost didn't matter what he said, as long
as he demanded an order and then fell completely silent. "Mr. Johnson,
this is Blaine Lourd from Lehman Brothers. We see Abbott Labs going to 60,
and I think you need to buy 10,000 shares of Abbott Labs today."
Half the time,
in the ensuing silence, Mr. Johnson would hang up. But the other half, Mr.
Johnson would explain, usually pathetically, why he couldnt right then
and there buy 10,000 shares of Abbott Labs. And once Blaine had a specific
objection, he had an obstacle he could overcome.
I've got to
talk to my wife.
if youre driving at night with your wife in the city, it's snowing,
and you have a flat tire, do you ask your wife to go out and change it?"
have the cash.
you have stocks in your portfolio that are underperforming. We'll take you
out of them to get you into Abbott Labs."
Why Abbott Labs?
it on good authority that it's Warren Buffett's next purchase."
The older brokers
in the office all threw around Buffett's name, so Blaine did too. Buffett
was useful because everyone knew who he was and everyone thought he had made
his money picking stocks. Blaine was picking stocks just like Buffett but
using different criteria. The traders in New York would accumulate a block
of shares, driving the price up, and then get brokers like Blaine to unload
the shares quickly at the higher pricewhereupon the price would, often
as not, fall. "Seven months in at Lehman, I was one of the top rookie
producers," Blaine says, "but every stock I bought went down."
His ability to be wrong about the direction of an individual stock was uncanny,
even to him. At first, he didnt understand why his customers didnt
fire him, but soon he came to take their inertia for granted. "It was
amazing, the gullibility of the investor," he says. "When you got
a new customer, all you needed to do was get three trades out of him. Because
one of them is going to work. But you have to get the second one done before
the first one goes bad."
It wasn't exactly
the career hed hoped for. Once, he confessed to his boss his misgivings
about the performance of his customers' portfolios. His boss told him point-blank,
"Blaine, you're confused about your job." A fellow broker added,
"Your job is to turn your clients' net worth into your own." Blaine
wrote that down in his journal.
Then he caught
a break. He met a girl who liked him. The girl went and told a friend about
him. That friend was the business manager for the Rolling Stones. One thing
led to another, and the Rolling Stones handed him $13 million to invest. It
was that easy. This money constituted their tour fund, and they didnt
want to take any risks with it. "I went to my office manager and asked,
'What do I do with this?' And he looked at me and said, 'I dunno.'" Blaine
was seriously unnerved: He knew how to sell stocks to strangers, but that
skill had nothing to do with preserving a pile of capital. "All of a
sudden, I got a real client," he says. "It wasn't from some cold
call. I didn't want to lose the Rolling Stones' money." He decided to
invest it in Treasury bills. "Right away, Im in conflict with the
firm. My colleagues gathered around this money and asked me, 'How are you
going to gross this thing up?'" Meaning how would they be able to maximize
their commissions. "And I said, 'What do you mean? Its in T-bills.
And they said, 'We can't make any money on this.' And that's when I said to
myself, I gotta get out of here."
He quit Lehman
Brothers and took a job at the Los Angeles office of Bear Stearns. But Bear
wasnt any better. He says he was pressured to make transactions rather
than give good advice. The stories he told himself to feel better about his
career became less and less plausible. The nicest thing he could say about
himself was that he hadnt broken the law. He hadnt bankrupted
anyone or anything like that. But when he stepped back from his job and really
looked at it, he realized that a huge amount of his time and energy went into
making people feel happy about his advice when they should have been furious.
The problem was the constant tension between company and client, caused by
the firms inability to know what the market or any particular stock
was going to do next. I always thought there was going to be a place
where the client wouldnt be compromised and the broker wouldnt
be compromised, he says. But it was the same everywhere. It was
all about getting people to transact. And these werent bucket
shops; they were Wall Streets most distinguished firms.
He gave up on
picking stocks and started picking fund managers instead. He'd sell his customers
not on Cadbury Schweppes but on some mutual fund that his Wall Street firm
was promoting. "I thought it was better than me picking stocks,"
he says. "But ultimately, these guys who ran the funds were just picking
stocks like I was. And they werent any better at it. The only
thing that changed was Successful Telephone Selling in the '80s. It now had
a new title: Successful Telephone Selling in the '90s.
Still, he was
a 29-year-old earning $200,000 a year, and he was, as he puts it, "ramping
up the lifestyle." Rival firms noticed his success: He left Bear Stearns
for Dean Witter, which would later become Morgan Stanley. Blaines business
grew to the point where he became somewhat famous. Name a prominent director
or big-time movie star, and there was a fair chance that Blaine Lourd was
giving her financial advice. He lived near the beach in Malibu, drove fancy
cars, and indulged an expensive taste for young women who had moved to Los
Angeles to become movie stars. He routinely ranked in the top 10 percent of
revenue producers for whichever firm he happened to be working for. In his
best years, he grossed more than $1 million. His father had been right: His
persuasiveness and ability to get people to like him went far on Wall Street.
Only now he
had a problem. He was quickly becoming the world's unhappiest man. He often
woke up with a sinking feeling in the pit of his stomach; more often, he woke
up with a hangover. Like a lot of his fellow stockbrokers, he started drinking
too much. "Everyone I worked with had a drinking issue," he says.
"Or a drug issue. You can't continually hurt people and feel good about
yourself." One day, he woke up to find he was a 37-year-old late-1990s
cliché: the self-loathing Wall Street salesman. He wondered what had
gone wrong and began mining his journal to write a memoir. His book, which
was influenced in part by a 1940 financial-industry critique, would relate
the sadness of his father's financial collapse, the sorrow of leaving home,
and the sordidness of his financial career:
The sole function
of a stockbroker/financial consultant/investment counselor is to get customers.
So how does a stockbroker go about getting customers? The best way is to be
born rich. Rich guys make good stockbrokers because generally they are lazy
and so can do little harm to the clients long-term financial well-being
by trading in the game of chance. The next best way is to circulate among
them and to convince them with a pleasing personality that you have the ability
to buy everything before the big riseand to sell everything before the
I was not rich.
One day, someone
may look back and ask: At the end of the 20th century and the beginning of
the 21st, how did so many take up financial careers on Wall Street that were
of such little social value? Just now, the markets are roiling, money managers
and investment banks are reporting disappointing returns, and people are beginning
to wonder if they chose the wrong guy in Greenwich, Connecticut, to take 2
percent of their assets and 20 percent of profits. But what if the problem
isnt the guy in Greenwich but the idea that makes him possible: the
belief that the best way to invest capital is to hand it to an expert? As
a group, professional money managers control more than 90 percent of the U.S.
stock market. By definition, the money they invest yields returns equal to
those of the market as a whole, minus whatever fees investors pay them for
their services. This simple math, you might think, would lead investors to
pay professional money managers less and less. Instead, they pay them more
and more. Twenty-five years ago, the most successful among them took home
a few million dollars a year; in 2006, more than 100 money managers made more
than $100 million, and a handful made more than $1 billion. A vast industry
of stockbrokers, financial planners, and investment advisers skims a fortune
for themselves off the top in exchange for passing their clients money
on to people who, as a group, cannot possibly outperform the market.
For Blaine Lourd,
American stockbroker, the mere fact that he landed in the middle of this industry
and became a success was reason enough to hate himself. But in Santa Monica,
as Blaine twisted himself into ever more intricate knots to disguise his inability
to pick winning stocks or money managers, his antithesis was rising. It was
a firm founded in 1981 on a simple idea: Nobody knows. Nobody knows which
stock is going to go up. Nobody knows what the market as a whole is going
to do, not even Warren Buffett. A handful of people with amazing track records
isnt evidence that people can game the market. Nobody knows which company
will prove a good long-term investment. Even Buffetts genius lies more
in running businesses than in picking stocks. But in the investing world,
that is ignored. Wall Street, with its army of brokers, analysts, and advisers
funneling trillions of dollars into mutual funds, hedge funds, and private
equity funds, is an elaborate fraud.
The firm, Dimensional
Fund Advisors, was co-founded by David Booth, who had worked at the University
of Chicago as an assistant to Eugene Fama. As a graduate student in the early
1960s, Fama coined the phrase efficient markets. D.F.A. sold its clients on
passive investing: Instead of looking for trading opportunities and paying
stockbrokers and fund managers, D.F.A. bought and held baskets of stocks chosen
for the sort of risk they represented. It didnt call these baskets index
funds, but that is more or less what they were. And theyalong with the
idea they embodiedwere growing at a sensational rate. In 1989, D.F.A.
was managing $5.2 billion; by 1998, the number was up to $28 billion. Then
the internet bubble burst, and even more people fled the stock-picking game.
In the summer of 2007, when I visited, the firm had an astonishing $153 billion
under management, $90 billion of which had come from individual investors,
through a network of professional advisers.
Back in the
old days, when investors believed that they were paying for some mysterious
wisdom, the buildings housing Wall Street firms were stone on the outside
and dark wood on the inside. Now that investors have learned to fear what
they cant see, the firms are in buildings made of as much glass as can
be incorporated into a structure without compromising its ability to stand.
The day I arrive at D.F.A.'s offices, I find 150 financial advisers in a glass
box, waiting to be educated in a seminar that lays out the D.F.A. way. The
coffee and pastries are free, the men and women wear suits, and the conference
room has the antiseptic feel of any other 21st-century firm. But the atmosphere
is entirely different from Wall Street. Theres no chitchat about the
market, even though it has been bouncing around wildly. Instead, two speakers
discuss how, knowing what we now know, anyone could present himself as a stock-picking
guru. "If you put a thousand people in barrels and push them over Niagara
Falls," one of them says, "some of them will survive. And if you
take those guys and push them over again, some of them will survive. And theyll
write books about how to survive being pushed over Niagara Falls in a barrel."
The other speaker
paces back and forth in the well at the front of the room. "Have you
seen the show Mad Money?" he says. "It's repulsive."
No one disagrees.
That they are here, preparing to join the thousand or so converts authorized
to sell D.F.A.'s funds to investors, implies their agreement. They're all
salesmen, but salesmen peddling an odd idea: Don't listen to salesmen.
In the beginning,
back in the 1980s, D.F.A. didnt sell to individual investors at all.
The funds sold themselves by word of mouth. Finally in 1989, D.F.A., with
some reluctance, agreed to allow financial advisers to steer clients
money into D.F.A. funds, but only after those advisers had demonstrated their
purity of heart. They must never, ever, sell individual stocks, try to time
the market, or suggest to investors that it is possible to systematically
beat the market. D.F.A. required its aspiring antisalespeople to fill out
questionnaires and submit to telephone interviews. If they passed those testswhich
thousands faileda team from the firm would dignify them with an office
visit and grill them on their beliefs about the stock market. "One of
the reasons we visit them, says Weston Wellington, one of D.F.A.'s principals,
"is just to see the office. If there are TVs blaring CNBC and people
running around screaming, we say, 'Wait a minute here.'" The final test
of ideology is the conference. Having demonstrated sufficient cynicism about
Wall Street, the financial advisers must pay their own way to Santa Monica,
California, and listen to speeches that explain why, if anything, they should
think even less of Wall Street than they already do.
naturally arises: What makes someone good at selling this curious attack on
the modern financial system? I ask Joe Chrisman, the interface between D.F.A.
and the thousand independent financial advisers who have qualified to sell
D.F.A. funds, "Of all these proselytizers, who is the most effective
at taking an investor who thinks he can beat the market and turning him into
someone who quits trading and hands his money over to D.F.A.?"
easy," he says. "Blaine Lourd."
Lourd started out on Wall Street, he had a mop of dark hair and the wild smile
of a Baroque painters idea of Bacchus. He was still young, thin, and
handsome, but as his career progressed, the smile changed, becoming, like
his eyes, narrower and more calculating. He was turning into one of those
men that old friends fail to recognize at their 20-year high-school reunions.
But here was the thing: The difference between who Blaine had been and who
he had become was entirely a matter of how he had set about making himself
a success. Hed been raised to go through life happy, without thinking
too much about it, but the career hed chosen had proved contrary to
his upbringing. Hed violated his nature, and his appearance was paying
happened. In 1996, at the beginning of the greatest speculative bubble in
the U.S. stock market's history, he attended Dean Witter's conference for
brokers whose sales ranked in the firm's top 5 percent. There, he found himself
seated beside a broker in his sixties, who struck up what Blaine says was
"a cynical conversation about the state of our industry." The conference's
speakers gave the usual patter about finding opportunities in the stock market,
and the older fellow must have noticed Blaine straining to take it all in.
"He's looking at me like, You're smart enough to know better than this.
But I'm not smart enough to know better than this. And he says to me, 'You
need to read Charles Ellis' book The Loser's Game.'"
the bookit's actually called Winning the Loser's Gameand took
it with him to Aspen on his Christmas vacation. There, on the first page,
he read "Investment management, as traditionally practiced, is based
on a single basic belief: Professional investment managers can beat the market.
That premise appears to be false."
Ellis, who had
spent 30 years advising Wall Street firms, went on with charts, graphs, and
more evidence than he needed to convince Blaine of the truth of that statement.
The problem wasn't Blaine; the problem wasn't even the firms he worked for.
The problem was the entire edifice of modern Wall Street, in which some peoplebrokers,
analysts, mutual fund managers, hedge fund managerspresented themselves
as experts and were paid fantastic sums of money for their expertise. But
essentially, Ellis argued, there was no such thing as financial expertise.
"I read this book," Blaine says, "and I thought, My whole life
is a lie, and everyone around me is facilitating this lie."
It took him
stints at three firms to figure out that Wall Street wasn't going to let him
act on his new conviction. From Dean Witter he went to Oppenheimer, and from
Oppenheimer he went to A.G. Edwards. "I was now an efficient-markets
theorist, he says. "But there was no product for an efficient-markets
theorist." At the peak of the internet boom, he sunk a bunch of his clients'
money into a fund called Roxbury Capital Management, which advertised itself
as a value investor. But then he noticed that Roxbury was buying big-name
tech stocks after huge run-ups, and he pulled the money out. He looked around
for money managers who minimized transaction costs, but when he found them,
he'd discover that they weren't on the list recommended by the firm he worked
for. "All these money managers were saying to us, 'Put your money with
us and hold on for the long term,' but they were turning over their portfolio
every quarter. They weren't holding for the long term." He brought up
his new qualms with senior managers, but they seemed to only pretend to listen.
"They knew that if they bought into efficient-markets theory, they'd
break their entire belief system and ultimately collapse their revenue stream."
He was no longer
cynical; he was outraged. At the end of every year, he'd circulate memos showing
that 80 percent of the money managers the firm promoted to clients had underperformed
the market. (An example of Blaine's market commentary: "This is a nonstop
jack-off to try to predict what is going to happen.") He received no
reply and realized his colleagues didnt care. So he saw their indifference
and raised it: He stopped attending the lavish conferences the firms threw
for top producers. "A fancy dinner, a round of golf, and a motivational
speech by Wayne Dyer all about overcoming obstacles," Blaine says. "It
had nothing to do with the market. It was about pumping you up and rewarding
you for your salesmanship." He told his clients he shouldn't pick stocks
for them or dump their money into actively managed mutual funds. Instead,
he'd put it all in index funds. For this service, he took an annual fee of
1 percent of their assets. "It was working great," he says. "Everyone
was happy. I was happy. The clients were happy."
was not happy. Blaine was still generating profits for his firm. Of the 6,000
A.G. Edwards brokers, he still ranked in the top 30. But for every dollar
that passed through his hands, he was slicing off a surprisingly small piece
for himself and A.G. Edwards. This brought a letter from the head of sales,
saying that while managers appreciated how much revenue he generated, they
wanted to see him generate 10 percent more. They want me to churn these accounts,
he thought. He fired off an angry reply and refused to trade. A few months
later, he received a visit from a local manager. It makes the Securities and
Exchange Commission unhappy, the manager said, to see brokers getting paid
for doing nothing. The U.S. government wanted Blaine to churn his accounts.
At that point, he says, "I was done."
In June 2006,
he quit and set up his own office in Beverly Hills. He called his new firm
Lourd Capital Management and started doing from outside the established Wall
Street structure what he had tried to do inside it. All but a handful of his
200 clients at A.G. Edwards left with him. He cast about looking for a home
far away from Wall Street where he could put his money, and remembered a friend
telling him about D.F.A. It was as if the place had been created with him
in mind: an entire firm premised on the theory that all of Wall Street floats
on bullshit. He called D.F.A.'s phone number. "What do I gotta do to
drop a ticket today?" he asked.
when he learned that he couldnt join the new religion until he proved
the sincerity of his faith. Before he could give D.F.A. his money, he had
to fill out an eight-page questionnaire about his investment philosophy. This
he did, with a feeling that "most of the questions were designed to trick
you into saying something you weren't supposed to say." Next came the
phone interview, which he assumed he passed, since two D.F.A. employees visited
his office soon thereafter. I sat around here answering their questions
for two and a half hours, he says. "Afterward, I thought we were
done, but one of them just said, 'I think we can continue with this process.'
I thought, Are you kidding me? Theres more? And they said, You
gotta go to a class.'"
The show at
D.F.A. breaks down roughly into two acts. Act 1 consists of speeches from
impressively credentialed academics who can explain why the efficient-markets
hypothesis is scientifically indisputable. The hypothesis is an odd idea with
an even odder history. In 1900, a French graduate student named Louis Bachelier
completed a dense thesis called Theory of Speculation, in which he concluded
that prices follow a random walkthat is, no information about past prices
enables a trader to predict future ones. Bachelier described the market as
an aggregate of speculators who at a given instant can believe
in neither a market rise nor a market fall, since, for each quoted price,
there are as many buyers as sellers. It made sense, but Bacheliers
superiors thought he was either out of his mind or dealing in trivia and blackballed
him for any job recommendations.
For 60 years, people traded stocks happily, gave stock market advice freely,
and paid brokers handsomely without anyones uttering a peep about the
theoretical futility of it all. Stock markets boomed and crashed, and financiers
jumped out the windows of tall buildings. Yet it occurred to no one to pick
up where Bachelier had left off. In retrospect, its clear that an economic
incentive to pursue the idea was missing. The only people who understood the
stock market well enough to wonder if its efficiency made predictions irrelevant
were the ones who made their living selling those predictions. But in time,
the American economy grew so prosperous and complicated that it could support
an industry of people who did nothing but analyze stock market prices without
a view to personal profit and loss. Professors of finance, these people were
called, and they made their living publishing papers on their subject for
an audience of dozens.
In the early
1960s, the efficient-markets hypothesis finally took off, thanks first to
Paul Samuelson, who reminded everyone of Bacheliers paper, and then
to Eugene Fama, who tested it against actual U.S. market data. Fama discovered
that the Frenchman had got it exactly right back in 1900: A person could learn
no useful information about future stock market prices by examining past performance.
Chart reading, graph plotting, momentum analysis, and all the rest of the
more esoteric Wall Street techniques for predicting stock-price movements
were hokum. Fama went further: No public information at all is of any use
to a trader trying to beat the market. Balance-sheet analysis, industry insight,
articles in the Wall Street Journal, a feel for the character of a C.E.O.these
are all a complete waste of the investors time, as whats already
known is factored into stock prices too quickly to act on it, and what isnt
known is inherently unpredictable. "The true news is random," says
Burton Malkiel, a Wall Street banker turned Princeton professor who published
the most famous book on the efficient-markets hypothesis, A Random Walk Down
Wall Street. "That's what people had trouble grasping. It's not that
stock prices are capricious. It's that the news is capricious."
of the randomness message was that investors must simply accept the miraculous
God-given returns of the stock market as a whole and resist the temptation
to try to exceed those returns. They must never believe they possess special
wisdom and judgment; the stock market has no use for human wisdom and judgment.
Fama attempted to go even further. His most radical hypothesis was that an
investor would not be able to profit even from private, inside information
about a company. His data ultimately forced him to reject this notion, but
not before he noticed how little insiders profited when they traded on what
only they knew. The rest of Famas hypotheses became academic gospel.
later, the combination of professional money managers fantastic ineptitude
and the power of Fama's argument has driven more than $1 trillion out of stock
picking and into index funds. Whats odd about index funds rise
is that it has occurred in spite of mounting evidence that markets arent
perfectly efficient after all. In the early 1990s, a counterview was hatched
on the fringes of academic finance. How can the market be rational if all
the people in it are not merely nuts, but nuts in the same way? If people
are crazy enough to pick stocks, time markets, and pump up mutual fund managers
who, in turn, dont know what they're doing, then why arent people
crazy enough to create systematic inefficiencies that smart investors can
exploit? For the better part of three decades, the efficient-markets theorists
brushed aside the question with a flick of the wrist: It doesnt matter
if individuals are mad. If crazy people drive prices out of whack, arbitrageurs
will rush in and bring them back into line.
But by the late
1990s, the question could no longer be dismissed so easily. What if the asset
being mispricedsay the entire U.S. stock marketoffers no obvious
arbitrage opportunity? The same behavioral-finance professors who delighted
in uncovering cases of human irrationality paused to point out specific mispricings
that arbitrageurs failed to correct. Economists Richard Thaler and Owen Lamont
penned an academic paper about the strange case of Palm and 3Com. After the
companies announced an opportunity to get one and a half shares of Palm for
every 3Com share, investors found themselves unable to do the math. When the
market opened the next day, the firms prices didnt come close
to reflecting the deals terms. If the market cant multiply
by 1.5, Thaler says, then how can we expect it to get the right
level of the S&P?
And what about
investors who systematically beat the market? Fama insisted that they simply
dont exist. If millions of monkeys throw a bunch of darts at the Wall
Street Journal, at least one monkey would pick a group of winning stocks.
training seminar, the firm now offers a more nuanced pitch. "It seems
to me a foolish argument," Ken French, a Dartmouth finance professor
and D.F.A. board member, tells the audience of financial advisers. "Can
Warren Buffett beat the market? I don't want to have that fight. Let's agree
for a moment that Warren Buffett is a wonderful stock picker. And he's magnanimous.
He wants to share his skill with investors. How would he do that? He cant!
The value of Warren Buffett's skill is already in Berkshire Hathaway's share
price." If by some miracle an investor comes along who can beat the market,
it is he, not you, who will extract the value.
Now in his late
sixties, Fama serves as a consultant to and board member of D.F.A., where
his main role is to buttress the convictions of each new platoon of financial
advisers and reinforce the idea that investors who try to pick stocks or time
markets are fools. He looks and moves less like a finance professor than a
retired bantamweight, but hes no longer much interested in the fight.
Forty years of preaching has taught him that his audience either agrees with
him or never will. And so he speaks dully, like a man talking to himself.
But he makes his point. In his years of researching the stock market, he has
detected only three patterns in the data. Over the very long haul, stocks
have tended to outperform bonds, and the stocks of both small-cap companies
and companies with high book-to-market ratios have yielded higher returns
than other companies stocks.
These are the
facts. The question is how to account for them. Fama's explanation is simple:
Higher returns are always and everywhere compensation for risk. The stock
market offers higher returns than the bond market over the long haul only
because it is more volatile and thus more risky. The added risk in small-cap
stocks and stocks of companies with high book-to-market ratios must manifest
itself in some other way, as they are no more volatile than other stocks.
Yet in both cases, Fama insists, the investor is being rewarded for taking
a slightly greater risk. Hence, the market is not inefficient. Everything
else in the stock market he dismisses with a single word: noise. You
can tell a story every day about stocks, he concludes. "Thats
what the media are all about. They tell a story every day about todays
stock returns. Its businessmans pornography."
pornography, as it happens, is Act 2 of the D.F.A. show. With more than a
little relish, Wellington, who gives as his credential his having a "master
of anecdotal evidence," gets up and picks apart Wall Streets phony
expertise and the media that feed off it. "What has been the role of
the financial media?" he asks and then answers his own question with
a series of damning slides. There's a shelf of financial bestsellers whose
titles now sound absurd: Ravi Batra's The Great Depression of 1990; James
Glassman's Dow 36,000; Harry Figgie's Bankruptcy 1995: The Coming Collapse
of America and How to Stop It. Theres BusinessWeeks 1979 description
of "the death of equities as a near permanent condition," and SmartMoneys
cover story "Seven Best Mutual Funds for 1996," whose selections
later underperformed the market by 6.7 percent. In 1997, SmartMoney found
seven new best mutual fund managers. They finished 3.4 percent below the market.
In 1998, the magazines newest best funds came in 2.2 percent below the
market. Soon after, Wellington says, "SmartMoney stopped its annual survey
of the best mutual fund managers."
the porn show with some general lessons. One is that the financial press isnt
in the business of supplying useful information; its in the business
of feeding peoples lust for predictions. You keep buying the magazine
regardless of how the forecasts turn out, Wellington says, and
theyll keep supplying the forecasts. Another is that if the best
mutual fund managers cant pick stocks well, how can you? A third is
that even putatively great money managers exhibit no ability to identify other
great money managers. When Peter Lynch retired from his sensational career
running Fidelity's Magellan Fund in 1990, his successors proceeded to underperform
the market. If you wake up in the morning and see Warren Buffett's face
in the bathroom mirror, Wellington says, go ahead and buy some
stocks. If you see anyone elses face, diversify.
And on he goes,
persuasively, but as he does, his comments evoke an obvious question, one
that no D.F.A. financial adviser dares ask: If all financial advice is worthless
and the only sensible strategy is to buy an index fund that tracks the market,
why would anyone need a D.F.A. financial adviser? Why, for that matter, should
anyone pay D.F.A. the 50 basis points it takes off the top of its oldest fund?
D.F.A.'s answer to this is interesting: It can beat the index. The firm doesn't
ever come right out and say, "We can beat the market," but over
and over again, the financial advisers in attendance are shown charts of D.F.A.'s
large-cap funds outperforming Standard & Poors 500-stock index and
D.F.A.'s small-cap fund outperforming the Russell 2000.
In each case,
the reason for D.F.A.'s superior performance is slightly different. In one
instance, D.F.A. found a better way to rebalance the portfolio when the underlying
index changes; in another, it came up with improvements in capturing small-cap
risk. All these little opportunities can be (and are) rationalized as something
other than market inefficiency, but they are hard to exploit, even with the
help of D.F.A. The lesson of efficient-markets theory is that when anyone
from Wall Street calls you up with financial advice, you should be very afraid.
But it isnt fear that prompts investors to embrace D.F.A. Its
a propaganda session," Blaine says, groping for the best analogy to describe
D.F.A.'s seminar. "It was beyond A.A. It was Leni Riefenstahl, but the
right way." Truth be told, for the whole two days of the seminar, he
had the unsettling sense that he was being watched. He kept his head down
and avoided saying anything that might cause D.F.A. to suspect he was still
an ordinary stockbroker. ("Had you said, 'I think small-cap value stocks
are inefficient,' I think you could get kicked out.") They weren't teaching
him; they were deciding whether he believed what he needed to believe to sell
their investment advice. This was new.
A couple of
months after attending the seminar, Blaine succeeded in getting $100 million
of clients' money into D.F.A.'s funds. He worked from his own little space
in Beverly Hills, which was, in its most recognizable feature, as unlike a
Wall Street brokerage firm as could be: It was completely silent. No TV blaring
CNBC. No squawk box. No urgency. "There's one decision," he says.
"We decide how much to allocate to various funds, and then were
done." He wonders why he would need any sort of real-time financial information
at all. "What am I going to do: Chart a stock? I think more and more
brokers will move to an efficient-markets strategy, because all of their products
go bad. They just do." The hours he once spent obsessing over financial
news, he now devotes to SportsCenter. Even his memoir, into which he put so
much effort, is on hold. "It's funny," he says. "I don't write
as much as I used to, because I'm happy now."
Last year was,
by far, the biggest year of his career. The assets under his management are
up 40 percent since he left A.G. Edwards. Hes still making money, but
his purpose in life has been turned on its head. Investors used to come to
him for tips. Now the same clients come to him so he can prevent them from
listening to tipsor hunches, or the latest rantings on cable TV. ("They'll
call and say, 'Well, Maria Bartiromo just said...'") His biggest problem
is dealing with new prospects. "They come in here, and their funds have
underperformed the market by 300 basis points, and the first question out
of their mouth is 'Whos your guy?' We have to reeducate them: There
is no guy. The guy is the market. The guy is capitalism."
His job, as
he now defines it, is to tell investors that the smartest thing they can do
is nothing. He acts as a brake on, rather than an accelerator for, their emotions.
For that, he takes between one-half of a percent and 1 percent annually, which
is more than theyd pay if they simply bought index funds on their own.
"I tell them, 'Look, if you can control your own emotions and you want
to go to Vanguard, you should do it.' And every now and then, someone asks
the question, 'Why do I need you, Blaine? What are you doing?' And I say,
'Howard, be careful or I'm going to send you back to Smith Barney.' And they
laugh. But they know exactly what I mean."
for all the world like a man who has made a separate peace. He works surrounded
by large black-and-white photographs of the Louisiana bayou of his youth.
If he were required to explain his career now to his 18-year-old self, he
wouldnt need to apologize. Every now and then, he feels the old itch
to be a player, but, as he puts it, "When I pick a stock, I do it for
my own account, never for clients." He's never going to make the really
big money ("This isn't a business model that funds a private jet"),
but as long as his clients need him to protect them from Wall Street and themselves,
his career has a higher purpose. Theres a hitch, though. Like a reformed
addict or an escaped prisoner, hes now defined by what he isnt
rather than by what he is. What happens when what he does is no longer new?
What happens when its no longer all that uncommon?
takes great pleasure in describing just how screwed up the American financial
system is. "In a perfect world, there wouldnt be any stockbrokers,"
he says. "There wouldn't be any mutual fund managers. But the world's
not perfect. In Hollywood, especially, people need to believe there's a guy.
They say, 'I got a friend who made 35 percent last year.' Or 'What about Warren
Then he pulls
out a chart. He graphs for me the performance of one of D.F.A.'s value funds,
which consists of companies with high book-to-market ratios, against the performance
of Warren Buffetts Berkshire Hathaway since 1999. While Buffett's line
rises steadily, D.F.A.'s rises more steeply. Blaines new belief in the
impossibility of beating the market doesnt just beat the market. It
beats Warren Buffett.