Portfolio Management Confidential

Bogie and Bacall in The Big Sleep; Source: Wikipedia

I recently had cause to reflect on the difference between a good securities analyst and a good portfolio manager. For a long time I believed a portfolio manager was just a leveled-up analyst. If you could identify one undervalued security, I reasoned, it would be straightforward to manage a basket of them.

Portfolio management and securities analysis are certainly complementary skill sets. But an exceptional securities analyst may only make for a mediocre portfolio manager and vice versa. The roles have certain fundamental differences.

The Role of Securities Analyst

A good securities analyst thinks like an investigative journalist. He should be detail-oriented and skeptical. He tirelessly pursues The Truth about the value of a security and the financial strength of its issuer. Like Raymond Chandler’s private detective, Philip Marlowe, the analyst confronts an indifferent world riddled with corruption and deceit. He faces constant pressure to abandon his pursuit of truth in favor of “going along to get along.” Sometimes this pressure comes from management teams of corporate issuers. Other times it comes from the analyst’s own organization (The Truth can be a considerable inconvenience to the powers that be).

This quote from The Long Goodbye sums up the state of affairs rather nicely:

“There ain’t no clean way to make a hundred million bucks…. Somewhere along the line guys got pushed to the wall, nice little businesses got the ground cut out from under them… Decent people lost their jobs…. Big money is big power and big power gets used wrong. It’s the system.”

The Role of Portfolio Manager

A good portfolio manager is a skilled poker player. Portfolio managers leverage analyst research to place bets designed to maximize expected value. The portfolio manager’s job is not to pursue The Truth, but to ensure her portfolio can withstand the cruelly random vagaries of securities markets. The primary concern of a portfolio manager is to balance risk and reward tradeoffs. In doing so, the portfolio manager is also concerned with the behavior of other market participants. At extremes, the fear and greed of others create risks and opportunities. For example, weak players often fold strong hands too early.

If this sounds a little like gambling, that’s because it is a little like gambling. Susquehanna International Group actually teaches their traders to play poker. However, the most important difference between portfolio management and casino gambling is that portfolio management is a positive expectation endeavor. In the long run, all casino gamblers are losers.

Chandler again (just for fun):

You were dead, you were sleeping the big sleep, you were not bothered by things like that, oil and water were the same as wind and air to you. You just slept the big sleep, not caring about the nastiness of how you died or where you fell.

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