Hindsight and investment advice

By Felix Salmon
October 14, 2010
Cullen Roche today revisits his advice from a year ago, which was published in New York Magazine, on how to buy toxic assets.

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Cullen Roche today revisits his advice from a year ago, which was published in New York Magazine, on how to buy toxic assets. He says that he “received a pretty substantial backlash from the article”, which is true: I wrote about it under the headline “Awful investing advice of the day, distressed-mortgages edition”. But now he’s defending himself:

First of all, I wasn’t making, nor do I ever make recommendations for anyone. That should be ABUNDANTLY clear to any and all readers of everything I write. I was simply brainstorming about the ways that small investors could gain access to toxic assets because it’s a relatively closed space to the small investor if you don’t have certain connections…

Even though these ideas were generated well after the market bottom the one year results prove that we were indeed in the midst of a once in a lifetime opportunity…

Unfortunately, the once in a lifetime opportunity is likely gone as the risk/reward environment has altered dramatically… In fact, distressed debt looks more crowded by the minute.

So does that mean, pace Joe Weisenthal, that I’ve been proven wrong?


Firstly, of course Roche was making investment recommendations — he was citing specific ticker symbols, ferchrissakes, and the first line of the piece (headlined “The Beginner’s Guide to Toxic Assets”) was this:

So how can you consider joining Michael Osinski and invest in toxic assets?

The entire piece, in other words, was presented as a way to give those “beginners” a “guide” for how to “invest in toxic assets”. You can reiterate until you’re blue in the face that you’re not giving investment recommendations, but a guide like this — especially if it comes with ticker symbols — is exactly that.

Secondly, the one year results are not particularly convincing. Roche’s own numbers say that his recommendations went up by 21% on average, compared to a rise of 11.45 percent in the S&P 500. But the 21 percent return figure doesn’t include transaction costs, and it certainly doesn’t make any attempt to account for the the fact that these stocks are inherently riskier than a big index of the largest companies in America.

Does the excess 955bp of return make up for that risk? Maybe it does — but it would be nice if Roche had told us in advance what kind of outperformance would constitute proof that his “once in a lifetime opportunity” thesis was true. Personally, I would expect that a once-in-a-lifetime opportunity would generate rather more than 955bp in excess returns, but maybe that’s just me.

Finally, and most importantly, the initial story didn’t give any kind of exit strategy. I’ll give Roche some small credit for posting exit advice on his blog today. But 99% of the people who read his original article on nymag.com will never see that blog post. And so if you took his advice a year ago, right now you’re just sitting on paper profits. And there’s no indication at all, in his original article, that you should sell after one year, or sell when the portfolio has risen by 20 percent, or even sell at all, really.

Every article saying that now’s a good time to buy X should be ignored automatically if it doesn’t say when you’re meant to exit that trade. (“Never” is a reasonable answer to that question, but if you’re giving buy-and-hold-forever advice, be explicit about that.) Given that NY Mag is unlikely to run a piece saying “hey, those stocks we recommended, now would be a good time to sell them”, it should never have run the article saying that it was a good time to buy them a year ago.

But hey, if someone at NY Mag is reading this, maybe a little blog entry might be in order. It can’t hurt, and it might save a few readers from following these stocks down after riding them up.


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I don’t understand the issue here…

(1) Yes, he recommended them. So what? Doesn’t mean that anybody had to listen.

(2) The fact that his recommendations are up relative to the market means that anybody who followed his advice is ahead. Hard to see the harm in that.

(3) If you don’t have a clue when to exit, then don’t invest in that security.

I would rather have knowledgeable analysts share their thoughts (and let me choose which to follow) than have them afraid of giving “inappropriate advice”. After all, ANY advice will be inappropriate for SOME investor.

Posted by TFF | Report as abusive

Felix, are you simply arguing that the positive outcome doesn’t change the fact that it was bad advice?

True, that!

Posted by TFF | Report as abusive

Writing a guide to something is not a recommendation to actually do the thing, surely? A semantic difference perhaps, but isn’t that how the law works?

Posted by FifthDecade | Report as abusive

I read a comment by Morningstar once that, regardless of their buy recommendations, investors should always do their own research, because “otherwise, how will you know when to sell?” This is the spirit in which I tend to assume buy recommendations are meant; the recommender recommends that you buy and sell when it’s time to sell. That wouldn’t be known ahead of time, and would be based on criteria similar to the ones that generated the “buy” suggestion in the first place.

Posted by dWj | Report as abusive

“The fact that his recommendations are up relative to the market means that anybody who followed his advice is ahead.”

But Felix’s assertion was that the toxic portfolio was riskier than the S&P portfolio. In that case, the opportunity cost portfolio – the one with the same risk – would be a leveraged S&P portfolio. That portfolio is also up relative to the market.

Which investment strategy performed best in hindsight? To answer that question, you have to be able to measure the risk of the two investment alternatives in order to know how much leverage would have equalized the risk of the two strategies. That is a contentious issue, but it is one that cannot be dodged; if you ignore it, that just means you are implicitly claiming that a given cash holding in S&P 500 and toxic ABS have exactly the same risk. That particular answer strikes me as implausible.

Posted by Greycap | Report as abusive

I see your point, Greycap. If I read the original recommendation at the time (don’t remember), I would definitely have discarded it on the basis of risk — not over the valuation.

Very hard to fairly price something if you can’t determine (and bound) its risk.

Posted by TFF | Report as abusive