Ricky Roma: I’m going to tell you something. Your life is your own. You have a contract with your wife? You have certain things you do jointly? Bond there. And there are other things, and those things are yours. And you needn’t feel ashamed, you needn’t feel that you’re being untrue. Or that *she* would abandon you if she knew. This is *your* life.
—Glengarry Glen Ross
Ricky Roma is the best salesman in the office. He’s at the top of the Cadillac board. And that’s no accident. Ricky Roma is a masterful storyteller. He knows all about needful things.
Ricky Roma’s stories appeal to us on an emotional level. But there are other, equally effective storytellers out there appealing to us on an intellectual level.
Much of what we think of as “financial analysis” is this second type of storytelling. Finance people tend to look down on writers and artists, but I can assure you there’s no less creativity involved in financial analysis. If you’ve ever built a discounted cash flow model, or an LBO model, you’re well aware of the enormous number of assumptions embedded in the things. Choosing a discount rate isn’t so different from a painter mixing colors on her palette.
Granted, that’s a fairly subtle example. Storytelling masquerading as analysis is much more obvious (not to mention silly) in the context of “portfolio update” and “strategy” meetings.
These are the meetings where a PM or strategist sits down with a slide deck and tells you about the state of a portfolio or the world. Make no mistake. There’s nothing analytical or scientific about this process. It’s theatre. The slide deck and the charts are just props to be used in the performance.
If the PM or strategist is a value guy, the story will be about mean reversion.
If the PM or strategist is a trend guy, the story will be about momentum.
The odds you’ll derive any decision-useful information from a performance like this are slim. To the extent there’s decision-useful information embedded in the performance, it’s in the metatext—the story of the story.
For example, there isn’t decision-useful insight embedded in a CE webinar about how floating rate securities have performed historically in rising rate environments. This is what I’d call a bagholder webinar. Same with sell-side research.
You don’t derive decision-useful insight from naively sitting through bagholder webinars and naively reading bagholder-oriented research. Do you honestly believe these firms produce research out of a deep, unwavering commitment to the Search For Truth?
No. Research groups are cost centers. They produce reports and exhibits in support of their salespeople. So always ask yourself: “why am I seeing this NOW?”
The first-order answer is usually that someone’s trying to sell you something. That firm hosting the CE webinar knows you know we’re in a rising rate environment. They know you’re worried about what it means for fixed income portfolios. Oh, look, they just happen to run a floating rate fund.
This may be a useful insight. But it’s also a trivial insight. Just because someone’s selling you something doesn’t mean it’s a bad deal.
More valuable insight comes from understanding the issuers of floating rate paper (via the sell-side) also know the firm running the floating rate strategy knows you’re worried about what rising rates mean for fixed income portfolios.
Put another way, what you need to address in your analysis isn’t how the asset class has performed historically. You need to address how the asset class might perform based on how deals are priced, structured and sold today.
Deal pricing is predominantly influenced by buy-side appetite for various types of securities. From there, it’s a matter of supply and demand.
The stories told by PMs and strategists and the sell-side and everyone else in the market ecosystem are told to influence our appetites for different cash flow profiles.
It’s storytelling that drives demand.
It’s storytelling that closes deals.
Remember this next time you’re parsing pro forma financial statements; or some chart illustrating the value/growth performance divergence; or a scatter plot showing how some asset class (*ahem* private equity) dominates everything else on a risk-adjusted basis.