Why analysts should not be investors, Andy Zaky edition
Back in October, Andy Zaky put out his sixth “buy” recommendation on Apple stock. The first five — in July 2006, November 2008, August 2010, June 2011, and May 2012 — all did spectacularly well, and all hit his price target within the time span he specified. Zaky was a first-rate Apple analyst, quoted by me and many, many others; as Philip Elmer-DeWitt says, he had “a series of spot-on predictions”, of everything from Apple’s earnings, to its iPhone sales, to — of course, its stock-price movements.
Smart and accurate Apple analysts are in high demand, and Zaky, quite sensibly, decided to monetize his gift. In June 2011 he put his blog behind a paywall, charging first $49 per month and then, in June 2012, $200 per month. With 700 subscribers, that meant a six-figure income per month, just by selling access to his detailed Apple analysis and trading recommendations.
Unlike most analysts, however, Zaky soon discovered* that his subscribers actually followed his recommendations — to the letter, in many cases. They weren’t using his analysis to inform their own decisions, they were outsourcing all of their decision-making to Zaky, simply placing the trades themselves. And so Zaky made a fateful decision: in that case, he might as well start his own hedge fund.
Bullish Cross Asset Management was launched in late 2011, and by November 2012 some 28 investors had invested a total of $10,607,815 with Zaky. And had lost it all. For Zaky, it turns out, was a truly dreadful fund manager: the kind of guy who not only put all his eggs in one basket, but the kind of guy who would also desperately double down upon incurring trading losses. With that kind of a trading strategy, even someone who’s right 85% of the time is going to blow up pretty quickly.
Zaky of course feels bad about this, and says he wants to make his partners whole, and “make things right”. But that would involve investing money, and investing money is clearly something Zaky is incredibly bad at. It’s easy and facile to sneer at analysts, saying that if they were actually any good at their jobs, they’d be making ten or a hundred times as much money by actually investing, instead of just putting out recommendations. But the fact is that analysis and investing are two very different skillsets, and while Zaky was very good at the former, he was very bad at the latter.
There’s no particular shame in that; sometimes you only learn your limitations by trying and failing. But the most astonishing part of the Andy Zaky story is not that he set up a tiny hedge fund which failed. Rather, it’s the lemming-like way in which the subscribers to his newsletter lost a mind-boggling sum of money — quite possibly well over $1 billion.
Elmer-DeWitt has heard from 36 former subscribers to Zaky’s newsletter; between them, they lost a whopping $92.5 million. Just one of them claims to have lost $50 million, or five times the total assets of Zaky’s hedge fund. If you ignore that one outlier, the rest of the subscribers have still lost an average of $1.2 million apiece — vastly more than the $380,000 or so invested by the average partner in Zaky’s hedge fund. And if you include the $50 million outlier, then the average loss rises to $2.6 million. Multiply either number by 700 subscribers, and it’s easy to see how total losses could reach the billion-dollar mark.
Reading Elmer-DeWitt’s original story, it’s clear that many of those investors were incredibly unsophisticated. And probably their self-reported loss estimates should be taken with a pinch of salt: they’re probably calculating their losses from their mark-to-market high point, rather than from the amount of cash they invested into trading Zaky’s recommendations. Still, this story is clear proof, in case any were needed, that you don’t need to qualify as a sophisticated or wealthy investor in order to engage in ridiculously risky trading strategies.
The Zaky story is depressing for another reason, too. The subtitle of his blog is “The Power of Compounded Returns in Holistic Quantitative Modeling” — it looks impressive, but it’s ultimately meaningless, and it naturally appeals to the ignorant. It can’t have taken Zaky very long to work out, on a subconscious if not a conscious level, that the best way to develop a reputation, and to build up his subscriber base, was to be as aggressive as possible in his calls, and to try to maximize both returns and risk. No one was going to pay him $2,400 a year to outperform Apple stock a little bit: these people were greedy, and wanted to shoot the moon. As such, they only have themselves, rather than Zaky, to blame for their losses. In fact, by creating a strong incentive for Zaky to ramp up the risk quotient in his calls, they probably helped turn a first-rate analyst into a busted investor: Zaky’s behavior, in some sense, was his subscribers’ fault.
Zaky, it’s clear, had much more value to the world of investing when he didn’t have skin in the game than when he did. That might be hard for a former trader like Nassim Taleb to understand, but the fact is that investing creates all manner of psychological feedback loops, which have to be managed with discipline. If you can’t manage those feedback loops, you’ll blow up — but at the same time, absent those feedback loops, you can still be a very perspicacious analyst.
Why did people take money they couldn’t afford to lose, and invest it in high-risk options strategies playing a single stock? Why did one person invest 50 million dollars in such strategies? And why did any of them trust a kid with no investing track record? It seems incomprehensible to me. But as Larry Summers famously said, “there are idiots. Look around.” You think a billion dollars is a lot to lose on Apple stock? Well, Macau’s casinos took in $3.4 billion of gambling revenues just last month. There will always be gamblers, and gamblers will always lose money. But it’s easy to see why Apple’s executives have historically paid as little attention as possible to the antics of the stock market.
*Update: Mick Weinstein points me to an unbelievably hubristic Zaky post from October 2011, which helps explain why people were following him so slavishly. There’s a whole section called “Bullish Cross Model Portfolios: The Importance of following our Models to the Letter”:
We’ve repeatedly mentioned over and over again that closely following the various Apple-based model portfolios to the letter is very key. That when we make a decision with regards to these portfolios, that decision is very carefully calculated and delicately executed to contemplate nearly every scenario that the market can throw at us. If you decide to deviate from the model, you’re likely to run into problems…
I could put out 10,000 pages of material and that wouldn’t even come close to scratching the surface of what goes into my decision making process. There is no way for me to practically reduce all of my knowledge, experience or reasoning abilities to the written word…
It is completely unreasonable to expect me to reduce every single thought or reason behind every decision we make to the written word. No one could do that… There is so much in terms of experience that there is simply no practical way I can teach people everything.
The equity markets is very much as complicated as the human body and it would be like asking a physician to teach you to practice medicine in a few months. When we make a decision, we try to do the best we can to give the core reasons behind that decision. But you should understand right now that (1) there’s very little that is lost on me, (2) there’s very little that you’ve thought of that isn’t already on my mind.
For 95% of people, this kind of thing is a huge red flag, saying “stay well away from this guy”. But for the other 1%, it’s weirdly comforting.