By both temperament and training, we Chartered Financial Analysts (CFAs) are a lot like accountants — reliable, ethical and well-grounded in the craft of investing.
As basically geeky folks who have been investing an average of four years to earn the designation, we eagerly and self-servingly buy into the notion that the CFA is the gold standard of investing.
But I’ll let you in on a secret.
Having just returned from the CFA Society’s Annual Conference in Singapore, I can reveal that these conferences struggle to match the excitement of, say, a mortgage brokers’ shebang in Las Vegas.
After all, there are only so many ways to slice and dice Harry Markowitz’s efficient frontier and Modern Portfolio Theory to make it interesting.
That said, the CFA society made a valiant effort by hiring 2011 economics Nobel Prize Laureate Thomas Sargent to speak to us on Bayesian probabilities.
Yet even that didn’t bring the house down.
So the CFA Society recruited a crack team of professional pundits and prognosticators who regaled us with entertaining tales about themes as varied as the pace of technological development; the travails of being a corporate whistleblower in Japan; and the predictions of hedge fund manager J. Kyle Bass, a Texas-based hedge fund manager who has been expecting the imminent collapse of Japan for the past three years.
Kyle Bass’ studied self-deprecating manner, his well-rehearsed one-liners and his Southern frat boy good looks all combined to make his pitch compelling.
But here’s the elephant in the room…
Here’s a guy with a pretty mediocre academic pedigree — Bass studied on a diving scholarship at Texas Christian University — and never had the sitzfleisch to sit through three or four years of exams to earn a CFA Charter.
Yet there was Bass on the very same stage as an economics Nobel Laureate was 24 hours earlier.
How the heck did that happen?
The Hedgehog versus the Fox
The academic Philip Tetlock examined such phenomena in his book “Expert Political Judgment” — whose conclusions extend far beyond the world of politics.
Tetlock divided the world of pundits into either Foxes or Hedgehogs.
His distinction was based on Isaiah Berlin’s observation that:
“The fox knows many things, but the hedgehog knows one big thing.”
Foxes have a complex, self-critical style of thinking that prevents them from building up excessive exuberance for their predictions.
Hedgehogs offer entertaining, broad predictions, shoehorning complex realities into an all-encompassing and sweeping vision of the world.
In the investment world, hedgehogs include “gold bugs,” “China Miracle” types and the techno-optimists of Silicon Valley. They are both doomsters (Jim Rogers, Peter Schiff, J. Kyle Bass) and Boomsters (Peter Diamandis, TED lecturers) — or both (Harry Dent).
Hedgehogs are essentially the professional pundits who keep us entertained by dominating the media and the speaking circuit.
In contrast, Foxes’ opinions are too measured, too complex, too subtle to get summarized in a sound bite.
As producers at CNBC Asia told me last week in Singapore “[Hedgehogs] simply make for ‘good TV.’”
The Hedgehogs versus Foxes Smackdown: Who is Right?
“The test of a first rate intelligence is the ability to hold two opposing ideas in the mind at the same time, and still retain the ability to function.”
— F. Scott Fitzgerald.
Tetlock put the predictions of Foxes versus Hedgehogs to the test.
The measured opinions of Foxes and their willingness continue to adapt to changing circumstances make them much better predictors in all arenas than hedgehogs.
In fact, Tetlock found:
“a perversely inverse relationship between… good judgment… and what the media prizes in pundits.”
And it’s not so much who the foxes are (i.e. whether they have CFAs or not), or what they say (whether they are right or left wing) that make foxes more accurate predictors.
It’s how Foxes think, and the way they approach problems.
Foxes’ opinions are more like hypotheses — subject to constant change as circumstances alter.
Unlike Hedgehogs who know it all — all the time — Foxes adapt to evolving situations as part of a balanced, tentative mode of thinking.
Here’s the way I’d put it:
Foxes are scientists.
Hedgehogs are salesmen.
Why Hedgehogs are Dangerous to Your Financial Health
Having been (ludicrously) threatened with a lawsuit by a well-known hedgehog for the sin of disagreeing with him a few years ago, I know that “Hell hath no fury like a hedgehog’s predictions scorned.”
Yet this hedgehog and others got a lot of things wrong over the past few years.
Gold did not go to $5,000 an ounce. You probably lost money investing in China. The euro had more than “10 days to live” as the Financial Times declared in December of 2011.
The cold, hard truth is that, as a group, hedgehogs are simply lousy investors.
Remember Elaine Garzarelli, who “called” the 1987 stock market crash?
She had to shut down her mutual fund for poor performance within a couple of years.
Last year, Harry Dent shut down his second investment fund based on his big-picture demographic views.
And what about J. Kyle Bass himself?
Well, his Japan Global Macro opportunity fund — dedicated solely to the ideas he lectured the CFAs about — is having a hard time.
As of a year ago, it was down over 60%.
And since that time, Japan’s stock market has rallied over 30% in U.S.-dollar terms.
So there is little doubt that Bass’ Japan fund is even more in the hole than it was a year ago.
Yet, Bass’ questionable track record didn’t keep the CFA Society from inviting him to lecture to 1,300 CFAs — none of whom would have jobs if the funds they ran were down more than 60% over the past three years.
Investing With Hedgehogs: Caveat Emptor
In his study, Tetlock concludes that the dominant danger of hedgehogs is hubris and closed-mindedness.
He cites the example of Stanford University Professor Paul Ehrlich, author of “The Population Bomb,” which predicted hundreds of millions would die of starvation in the 1970s.
But the fact that 40 years later, Americans are fat and happy — rather than skinny and dead — never convinced Ehrlich to change his mind.
After writing a hefty check to Julian Simon after losing a bet that five commodities would increase in price in the 1980s, Ehrlich defiantly compared Simon to a man who jumps from the Empire State Building and, as he passes onlookers on the 50th floor, announces: “All’s well so far.”
“A hedgehog convinced against his will is of the same opinion still.”
More importantly, before you hand your money to a hedgehog to manage, understand that hedgehogs are like late-night TV ministers.
They’ll draw you in with their fire and brimstone predictions.
But as with those late-night preachers’ pleas for money, watch your wallet.
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