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Wall Street: Land of Losers

September 14, 2008
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Todd N Kenyon

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As Lehman Brothers crumbles, I think few would question that many on Wall Street are losers. To take it a step further, I believe there is no question that investment management is truly a loser’s game. This was first elucidated by Charles Ellis in a seminal 1974 paper in the Financial Analysts Journal. Ellis defines a loser’s game as any competition where the outcome is decided by the loser’s actions, as opposed to the actions of the winner. For example, only at the top level of sport do the skillful moves of the winner determine the victor. Ellis uses tennis as an example (as cited in a book by Simon Ramo), where most matches are won by he who makes the fewest errors. Only the very best players WIN points, the rest of us LOSE points. The way to win a loser’s game is to lose less than your opponent.

The parallels to money management are strikingly obvious. What are Buffet’s first rules of investing? Rule #1: Don’t lose money Rule #2: Don’t forget Rule#1… Even Buffett, who would likely be at or near the top of anyone’s list as a “winner” knows that investing is a loser’s game. Yet most Wall Streeters are always trying to win, to make more money than then the other guy, thereby eliminating the possibility of a winner’s game existing. As Ellis said:

“The trouble with winner’s games is that they tend to self-destruct because they attract too much attention and too many players - all of whom want to win.”

Even back in 1974 Ellis realized that the stock market was changing, that money managers were no longer competing against amateurs who had limited access to information, they were competing against themselves. 34 years later, that phenomenon is now exponentially more true. Anyone and everyone has instant access to the same financial data, news, and trading resources.

We can certainly extend this thesis to banking. As the big boys all sought to beat each other they failed to consider the downside, failed to consider the possibility that they might lose it all. Those who played conservatively, who understood that they were playing a loser’s game, live on. Lehman thought they were playing a winner’s game - they still do. Perhaps this is fed by the fact that intelligent people, as Ellis says, are so proficient at developing and articulating “self-persuasive logic to justify the conclusions they want to keep.”

Does all of this then lead me to embrace Efficient Market Theory - the notion that at any time liquid assets are priced “correctly” and hence it is futile to try to beat the market? Absolutely NOT! You need look no further than the tech bubble or even recent real estate pricing to prove to yourself that assets are frequently mis-priced. The problem is that active managers in aggregate cannot beat the market net of expenses - they are the market after all. Can some managers beat the market consistently? I believe they can. But how does one indentify these managers before the fact? That is a topic for another post, but I believe it has to do with process and environment. The very environment in which most mutuial funds and brokers operate unequivocally eliminates any chance of outperforming the market.

How then should thoughtful investors operate within this loser’s game? Ellis provides some excellent insight via military and sports analogies. The parallels to Graham and Buffet’s “game plan” are striking.

First, says Ellis, make sure you are playing your own game:

“Impose upon the enemy the time and place and conditions for fighting preferred by oneself.” - Admiral Morrison

“Give the other fellow as many opportunities as possible to make mistakes, and he will do so.” - Ramo

Buffett:

“We don’t get paid for activity, just for being right. As to how long we’ll wait, we’ll wait indefinitley!”

“We only think about the pitches we swing at… It’s the “Swing, you bum!” from the stands that makes you swing at bad pitches.”


“The market is there only as a reference point to see if anybody is offering to do anything foolish”

Second, keep it simple. “Try to do a few things unusually well.”

“Play the shot you’ve got the greatest chance of playing well… Simplicity, concentration and economy of time and effort have been the distinguishing feature of the great players’ methods, while others lost their way to glory by wandering in a maze of details.” - Tommy Armour on golf

Buffett:

“Draw a circle around the businesses you understand… The most important thing in terms of your circle of competence is not how large the area of it is but how well you’ve defined the perimeter.”

“If you have to go through too much investigation, something is wrong.”

“If calculus or algebra were required to be a great investor, I’d have to go back to delivering newspapers.”


“Investors should remember that their scorecard is not computed using Olympic-diving methods: Degree-of-difficulty doesn’t count.”

Third, and this one is really key and something that even Buffett has admitted to messing up: invest defensively by concentrating on selling. Ellis says too much time is spent on the buying decision - one should focus more on selling. As he says,

“Almost all of the really big trouble that you’re going to experience in the next year is in your portfolio right now; if you could reduce some of those really big problems, you might come out the winner in the loser’s game.”

I plead guilty to this myself and have made a concerted effort to reduce fully valued holdings in my portfolios.

If we agree that money management is in fact a loser’s game, then the simple way to succeed is by losing less. Avoid trying too hard, or stretching for results. Following this simple advice would have prevented the entire housing crisis and the collapse of Bear Stearns and Lehman. Of course that is asking way too much of Wall Street, for Wall Street full of nothing but “winners”.

Of course, as Ellis said, “only a sucker backs a “winner” in the loser’s game…”

About the author:

Todd N Kenyon
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 3.5/5 (22 votes)

Comments

DaveinHackensack
DaveinHackensack - 5 years ago
"As Lehman Brothers crumbles, I think few would question that many on Wall Street are losers. To take it a step further, I believe there is no question that investment management is truly a loser’s game."

I saw no point in reading past the second sentence here. Money management is a relatively minor division of Lehman, and it's not what got them in trouble. Money management is usually a great business. Look at the long term performance of pure-play money managers AB and TROW, for example.
traderashish
Traderashish - 5 years ago
Wall street is not land of losers. Wall street makes lot of money and people in wall street are very rich.

It is the people who use their services...listen to the analysts and give them their money to invest for them... thats the losers game. Clients lose...
Amit Chokshi
Amit Chokshi - 5 years ago
Wow, what another original article, some money manager poses some thoughts and then has to bring in some WEB examples. I think WEB is the best but I'd almost argue the marketing/false association/ingratiation of WEB sayings/actions has lead to more destruction of value than WEB created himself. He's basically a zero-sum proposition himself. What do I mean by that? take for example when attending something like the Value Investing Congress when guys like Tom Brown will say in 1991 WEB bought WFC and everyone thought he was crazy, yada yada yada, and then Brown goes on to offer something like FMD where all of his clients lose their a sses. Take someone like PZena or Miller who has interestingly been citing WEB too as they lose BILLIONS for their clients.

Too many false idols and charlatans that use thegood name of the absolute best to raise capital when in reality most of these guys couldn't shine WEB's shoes. Hey, be greedy when others are fearful...want to invest in my fund? That's sort of the way it works from what I see.
adamcz
Adamcz - 5 years ago
Agreed Dizzy. However, WEB has helped many of us individuals become much better investors. The #1 lesson for me is "better to buy a great company at a reasonable price than a reasonable company at a great price," or however he phrased it. The secret to not losing money is to keep the average companies out of your portfolio altogether. If you listen to "be greedy when others are fearful" without remembering to buy only solid companies, you can't expect Buffett-like returns.
Amit Chokshi
Amit Chokshi - 5 years ago
You're right, I think it's unfortunate "professional" money managers like Tom Brown, Miller, Pzena and many others could not realize that.

I think WEB's statement re great cos and reasonable prices is ok for very long-term investors but successful money managers need to appropriately dial in better risk/rewards. With 8000+ stocks out there, there are many great opportunities and WEB probably did the best when he did invest off value more than the blend. Stocks like KO, WPO, AXP, etc are great businesses which he bought at phenomenal prices.

Even WEB's best returns with the partnership were prob driven mostly from great valuation opportunities irrespective of the actual business. Munger is the one that sort ofpressed that idea on WEB and it served him well as BRK became huge but i think WEB would say if u run $1 billion yes B or less, going for smaller opportunities makes for better returns. the key is to not hold forever, a 3 year holding period is prob the best.
DaveinHackensack
DaveinHackensack - 5 years ago
Judging from this column and some of the comments on it, there seems to be some confusion here. "Wall Street" isn't the same as the investment management business. Investment management (also called money management and asset management) is only one of several Wall Street businesses, and it's usually a relatively small part of of most Wall Street firms. Investment banking, securities underwriting, proprietary trading, and other businesses are much more significant components of traditional Wall Street firms. The biggest investment managers in this country tend to be stand-alone investment managers that are non-Wall Street firms: Fidelity, Vanguard, and The Capital Group Companies (owners of American Funds).

To take the specific example of Lehman Brothers, it didn't acquire its asset management division, Neuberger Berman, until 2003. That division was not the cause of Lehman's problems, and in fact, is valuable asset that Lehman is trying to sell to make up for losses in its other lines of business.
sapcap
Sapcap - 5 years ago
DaveinHackensack - my thoughts exactly.

I think the question now is, who benefits from LEH & BS going under and MER being bought out? Just two years ago AG Edwards was criticized for being too conservative. AGE did not have a mortgage division, did not have any proprietary funds (hedge funds & traditional), and AGE was not involved with any structured products and had no exposure to any of the toxic paper on its books. AGE was bought out by Wachovia for $89.50 per share and a year later Wachovia stock is down 76% due to its exposure to the mortgage market and other toxic paper on its balance sheet. I mention this because AGE as a stand alone company would have sailed through this current crisis, just as it had in past crises and just as another independent firm has today. That firm is Raymond James, RJF. I have not done any in-depth research on RJF but its stock price seems to indicate that it has a very strong balance sheet and little or no exposure to the current credit crisis. Further, as competition in the retail brokerage business continues to shrink I think RJF could benefit and use the current environment to pick up market share. RJF has $211.3mm in long term debt and $669.5 in cash on its balance sheet. In other words LTD is only 31% of its cash on hand, hardly an area of concern. Again, I have not done an in-depth analysis of RJF’s balance sheet but my guess is that I will find nothing of concern.

DaveinHackensack
DaveinHackensack - 5 years ago
It's an interesting question, SapCap.
commodity
Commodity - 5 years ago
The stock market is a casino.

Nothing about it is predictable.

The retail investor does not know this.

Fees and commissions is where the big money is made.

Let the suckers play the market.

They have no idea what the odds are.

tnkenyon
Tnkenyon premium member - 5 years ago
I appreciate the comments but I think I may been been misleading in my opening paragraph. I did not mean to imply that Lehman's issues were caused by a failing money management business. I made a bit of a leap from stating that the IB's like Bear and Lehman are true losers to saying that money mgmt is a "Loser's game" as defined by Ellis. That was not meant to imply it is a bad business - I tried to show in the rest of the article that it can be a good business if played like the "loser's game" that it is - more simply put, be defensive. I then brought in Buffett as an example of a "winner" that wins because he plays the "loser's game" properly.
batbeer2
Batbeer2 premium member - 5 years ago
>> The very environment in which most mutuial funds and brokers operate unequivocally eliminates any chance of outperforming the market.


Exactly.

LTCM will beat WEB 9 quarters out of 10. Many (hedge)funds operate in an environment (Wallstreet) that will stimilate such bevahiour. It's the remaining quarter that matters.

1) It wipes out LTCM completely.

2) It offers WEB, Bercowitz, Kahn et al some huge opportunities due to forced selling.

After a while, new and improved LTCM's are born.... and we start all over. Many forget about the real losers (they aren't around anymore) and focus on the new short-term winners in a losers game.
Amit Chokshi
Amit Chokshi - 5 years ago
Todd,

We can all likely agree that money management is a losers game but an awesome business. only business where u can fk up over and over again and steal people's money. Look at guys from Miller to Niederhoffer, in any industry they'd be crooks but in money management they're idols. But I'd argue with you that playing defense in the MM industry is the worst way to go, almost because it's a game theory issue.

If you assume that most will underperform over time, then your near term results are the most important since time is working against you, so you have every incentive to risk the house on great returns. Making 10% or 15% for one year is ho-hum, it's good but does that make people line up to invest? No, because despite all the focus on risk, people don't care about what risks are involved and care solely on the return. So a one stock portfolio bet levered to the hilt that gets a 250% return v a 15% return based on ultra conservative liquid portfolios would attract more investors meaning more management fees and a better business. Plus the higher the return for a year or two, the more that acts as a sticky anchor for existing investors.
tnkenyon
Tnkenyon premium member - 5 years ago
Dizzy - I agree. The paradox is that by the time you discover whether a manager really has skill or not it's too late. True investing works over very long time periods, way longer than most people can deal with. This will be the subject of another article soon - process vs. outcome. Wall Street and most "investors" are totally focused on short term outcomes regardless of the process involved. I think the only way to evaluate a manager for potential skill is to evaluate his process, hopefully along with a fairly lengthy record. Buffett puts forth a convincing argument that value investing works in his "Graham and Doddsville" classic. Most "investors" could care less however. Take Bill Miller. He had some decent outcomes over a long period of time, vaulting him to legendary status. Now, he looks legendary for another reason. What about his process? Certainly he has some unorthodox holdings for a value guy. I think you could've seriously questioned if he was/is really a resident of Graham and Doddsville...
DaveinHackensack
DaveinHackensack - 5 years ago
"I made a bit of a leap from stating that the IB's like Bear and Lehman are true losers to saying that money mgmt is a "Loser's game" as defined by Ellis."

No offense Todd, but this was an unclear, poorly-written essay. You bring up the collapse of Lehman even though its collapse was unrelated to the firm's money management business, and you use the term "money management business" when you seem to mean, simply, "investing". They aren't the same thing. You can do well in the money management business without being a great investor. Fidelity does great in the money management business. So does the Capital Group Companies' American Funds. So does Alliance Bernstein, for that matter. How many of their respective portfolio managers are considered gurus? How many of you even could name a Fidelity or American Funds or Alliance portfolio manager without looking it up? Fidelity, The Capital Group Companies, and Alliance each manage several times the money Buffett manages within Berkshire Hathaway.

If money management (as opposed to investing) were such a "loser's game", there wouldn't be so many profitable mutual fund companies.
Amit Chokshi
Amit Chokshi - 5 years ago
I've posted my thoughts on Bill Miller, in short he was a beta riding dip buyer in the strongest secular bull market on record, between the LM marketing machine and media he was a fake legend, now proven to be (as I've always felt to the chagrin of friends/family that got hosed by him in VT) a fraud.

The problem with time is it kills if you're stuck with a hack manager. Evaluating process is important but frankly the portfolio management and stock selection process could be fine but the analysis behind the individual ideas suck so an investor gets hosed again. Too many value guys glom onto P/Es, P/B, and other metrics without digging under those metrics and end up holding big time value traps. Since I run long/short stocks I find my best shorts are the value traps, low P/E stocks as opposed to high valuation ones from a risk/reward basis.

Also, for all of the independent minded thinking that value investors try to promulgate, the reality is if you look at the 13Fs of these guys, they're all copycat holdings and a lot of the same old tired "value" stocks. Look at the crossover holdings, guys like Tilson are just riding the coattail of the Ackmans of the world and charging 2/20 for it.

Look at how many "value" guys own SHLD, TGT, AEO, AXP, etc. I mean, look so many guys can't be wrong could be one way to look at it, but what if they are since it's rare to find people challenge the great Bill Ackman, after all we've all forgotten he blew up at Gotham Partners?

The issue, and this may be more on the fund manager, but it's what value are you adding to clients by investing in these same mundane holdings. I say that because guys like Tilson and plenty others have the WEB quotes roll of their tongues quite smoothly but so many of these guys manage capital that would allow them to invest ANYWHERE yet park it in copycat holdings which to me promotes dangerous circular thinking. Tilson got burned on TGT, BKS, BGP following Ackman into that, i think Shubenstein and Tilson had some x-over holdings that killed them. Pabrai/Tom Brown had some similar types of holdings too. I think these guys do some cursory research AFTER seeing a respected peer in a stock and then go in and get their a sses handed to them.

The most important aspect is that their clients probably have capital in plenty of index and mutual funds that have exposure to big cap companies. If you run $100MM-$1B, you''re best risk/reward should be in lower stocks not to mention the diversification benefits one would provide to their clients. Can you imagine WEB running $500MM and investing in SHLD or AXP? He only took AXP to 40% during the salad oil crisis and never looked back. If WEB was running $100MM or $500MM i'd guarantee it would be in obscure holdings most people never heard of and would have 0 stocks in common with the current value studs who seem to copy one another.

So what's the point of all this? the process is important but security selection is paramount too and the bottom line is despite all of the WEB quotes used to market one's fund offerings, you'll find that there are very very very few people in the world that have the analytic rigor to really value a business like WEB. I'd rather put my money in an index than give it to guys like Olstein and other blowhards.

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