Market commentators do not care one jot whether their opinion helps you to capture alpha. Their primary objective is to capture your attention as feedstock for their own machinery. You would be well served to have as your default position that market commentators are a hostile force intent on hijacking your attention for their own ends.
Market commentators in the media who do not have some unique insight must do something to compensate for that deficiency. They need to dial up their opinion to be heard above all the other noise: their views need to be more extreme, their story more compelling, their conclusions more certain. These are the tactics that are employed to capture your attention, and they are hostile to your endeavour to capture alpha.
The market opinion that you get from the financial TV channels is like a mild form of crack, designed to give you a little rush by creating the impression that you are in the middle of the action. You know that having the TV on isn’t good for you or your performance, but it’s on anyway. The shows are anchored by breathless women with good teeth or frowning men in bowties who preside over a conveyor belt of earnest talking heads. Even though some of those talking heads are respected members of the sell-side and buy-side communities, their opinion in the media gives you zero advantage over your competitors. The TV anchors want you to surrender your precious cognitive resources to them, and in return you may just get a momentary rush. It’s not a good deal.
Not all media opinion is noise, though, and a wholesale tuning out of media is not the best approach. Useful information almost always comes wrapped in layers of noise, and so when you reject the layers of noise, you can end up losing the information too.
This seems to suggest that noise management is a matter of refining your filters so that you tune out the dross and get the good stuff. That’s a good practice, but you need to be careful about the filters that you use, so that you don’t inadvertently create an echo chamber where you are soothed by hearing your own opinions being reflected back to you by others, where you mistake high quality commentary for what you already think, and you don’t get any dissenting opinion to give you a reality check. This is classic confirmation bias, where an error in calibrating your media filters can have the unintended effect of making you vulnerable to nasty surprises. A better idea, even though it’s almost always uncomfortable, is to actively seek high-quality opinion that challenges your thinking.
If the sell-side community is to be something other than a source of pure noise to you, the legion of strategists and analysts need to tell you something that both fits your investment process and which can be translated into alpha. If they don’t meet both of those criteria, then even a crisply articulated and original opinion is merely pretty noise, at best a distraction.
If you are sufficiently cynical or experienced, you probably ignore sell-side recommendations and you use their analysis and predictions to give you a sense of anticipated trends in fundamentals. The bad news is that the prediction track-record of communities of experts, including the sell-side, is no better on average than random guessing. Philip Tetlock (Superforecasting) has convincingly shown that the forecasts of the average expert are about as accurate as those of a dart-throwing chimpanzee.
A few strategists have built lucrative careers on the basis of a single extreme prediction that, luckily for them, turned out to be correct. Most other strategists realise that this is a very risky way to earn a crust, so they play it safe and don’t stray too far from the herd. The result is that most sell-side predictions represent the consensus and therefore offer no direct alpha-generating opportunities, while a few forecasts are wild haymakers that rely heavily on luck.
But despite these very obvious shortcomings, the sell-side can add value to your quest for alpha. You need to know what the consensus is if you want to take a non-consensus bet, and the sell-side community provides this valuable service. And the more extreme predictions can be valuable if you use them as a stimulus to challenge your own thinking. Beyond that, though, virtually everything else from the sell-side is noise, no matter how confident or eloquent the opiner.
You need to be careful to not conflate confidence with expertise or insight. When no-one knows what the future looks like, you need to beware of those who pretend that they know, and especially beware those who believe that they know. When you are overconfident, you’re flirting with danger; but when you rely on someone else’s overconfidence, you’re courting disaster.
If your competitors on the buy-side go out of their way to help you form an opinion about how they are positioned, you might want to treat that intel with a little suspicion. Very few of them would be so naive as to hand you their investment ideas if it did not serve their own interests. So when the fund managers that your clients see as your closest competitors appear on TV or radio or in the paper or on social media, it is more than possible that you are their real intended audience. They are probably talking their own book and their opinion must be treated as dangerous noise. It’s very likely that they want you to get excited about their story so that you bid up their position and provide the liquidity for their exit.
But there is someone whose market opinion is potentially more lethal than that of your biggest rival, and that person is you. Your own opinions can seriously undermine the quality of your decision-making. Of course, you have to formulate opinions about securities and markets, and some of those opinions need to be strongly held in the face of general disagreement; that’s part of your job, it’s part of taking a non-consensus view to capture alpha. But there is a point where your opinion becomes too firmly held, and becomes something to be defended at all costs, and sometimes one of those costs is the loss of your ability to admit that you are wrong.
When you repeatedly express a strong opinion, perhaps to members of your team who don’t yet see what you see, or perhaps to clients who are jumpy after a couple of poor months, or perhaps because you’re really confident that you’re right, that opinion starts to look like the one and only truth rather than one of a number of plausible stories. When your opinion morphs into being the Truth, then you will have crossed the threshold that separates your need to be right from your desire to generate alpha, and these two things are by no means identical.
When you become too attached to your thesis, which often occurs through forceful and convincing repetition, you become prone to confirmation bias, where any additional “analysis” is simply an elaborate way of justifying your prior decision. If things don’t pan out as you expect but you keep clinging to your cherished story, you will keep fighting when you should flee, or you will abstain when you should participate, and that’s an invitation to a whole lot of unnecessary pain.
- Which existing sources of opinion might you filter out?
- Which new sources of opinion might you actively seek?
- How might you better navigate your way though your own opinions?