Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street - Janet M. Tavakoli [29]
Robert Cialdini, Ph.D., wrote about confidence men in his book, Influence. Grifters know that glitz, honorific titles, and seeming sponsorship of well-known institutions have a powerful influential effect on us, and they do so without any conscious effort on our part. Investment banks tend to lend money just because another investment bank has lent money due to pluralistic ignorance. The second bank to lend will assume the first bank checked out the borrower, and it will skimp on its due diligence. We look around to see what the other guy is doing, and if everyone else is doing it, we go ahead. As Warren Buffett admonished in his letter to his All-Stars, don’t do something just because “everybody else is doing it.”15
Fortunately, Dr. Cialdini points out that all we have to do avoid being fooled is to make a conscious decision to look for counterfeit social evidence. People can rent virtual offices, expensive homes, flashy cars, and eye-popping jewelry. They can infiltrate the alumni list of a prestigious business school. Question everything. By the way, Robert Cialdini got his Ph.D. in psychology. Did you even question me? But if Cialdini’s Ph.D had been in art history, you would be right to be upset with me for citing him as an expert in psychology.
Irrational hype should make an investor skeptical as should any claim of intellectual superiority or mystical abilities. Some men seem driven to self aggrandizement. When Father W. Meissner’s psychobiography of St. Ignatius was published in the 1990s, shock waves reverberated through the Catholic Jesuit community. Ignatius was born to a noble Spanish family and aspired to become the paragon of hidalgos; he was a soldier, courtier, and seducer. After a canon ball shattered his leg, Ignatius devoted his energies to founding the Society of Jesus. Meissner claimed he displayed the symptoms of a phallic narcissist: exhibitionism, self aggrandizement, arrogance, unwillingness to accept defeat, and a need for power and prestige. Phallic narcissists can have “counterphobic competitiveness and a willingness to take risks or court danger in the service of self-display.” This “ruthless drive” may give them the “appearance of strength of character and resourcefulness.”16
In other words, the biography of the saint read like the profile of many a hedge fund manager.
Alfred Borden, a magician played by Christian Bale in The Prestige, counsels a small boy on the art of illusion: “Never show anyone anything. No one is impressed by the secret. It is what you use it for that impresses.” Borden offers this advice right after showing the lad a cheesy coin trick.
Just as a private investment portfolio can maintain secrecy, hedge fund strategies can remain a proprietary secret. Hedge funds that have a “patented” investment strategy or that feel they have a “proprietary” model that only they, “the smartest guys in the room,” have discovered, are probably bad bets. The usual excuse for secrecy is that they do not want someone else to copy their trades or manipulate the market and damage their profits. That was Long-Term Capital Management’s excuse, until it blew up and had to disclose its positions to its creditors. Sometimes there is no strategy other than to employ as much leverage as possible with the hope to get lucky.
What if the secret strategy means your hedge fund manager invests in a diversified stock index fund portfolio and pays fees of only about 0.1 percent per year while charging you much more? How would you know? Suppose your hedge fund manager thinks the stock market is going to tank. When a hedge fund manager has more than $1 billion in funds under management, he can invest in virtually risk-free T-bills and do well