Financial analysis education became too analytical and de-humanized. It needs to get back to more balanced, human, basics.
3 years ago, as every year for 8 years now, I volunteered as a “mentor” in a student financial analysis contest known as the “CFA Research Challenge”. During the French final, one of the student team was confronted with a very harsh and deep-meaning question about investment, a question they did not expect, a question they should have been taught about.
It was memorable because, while anecdotic at the time, it reached to something bigger, a problem that undermine the way young investment professionals (and some older) relate to their job. A question about the meaning of it.
The contest, which oppose once a year teams of brilliant students from universities around the world, consists, at the local (French) level, in the redaction of an equity research report, followed, for the finalist teams, by a 10 minutes presentation of their work to 3 experienced industry professionals, and a 10 minutes Q&A.
The company they all researched that year was Orpéa, a big nursing home manager in France. They were smart and hard working students, and their report and presentation was indeed very serious, quantified, focused on various metrics showing why one should invest in this company. They boasted about the industrialization the company achieved in the management of the houses, and the reduction of costs they managed to deliver… and so on. Technical, surgical and no mention whatsoever to the very sensible nature of this business, and how this was or not even relevant.
But then came the Q&A, and amid various technical questions, came the question they did not expect. And the hit came from a well-known and successful fund manager in France. The very person they did not expect this unexpected question to come from.
“Okay this is great, but honestly, would you like putting your own mother in those nursing homes ?”
Deafening silence. Confusion in the team.
They had 2 choices :
1 – Say no, which was obviously the good answer but was in blatant contradiction with all the very precise and theoretical model they just presented, not even talking about the very “professional” and capitalistic image they were trying to uphold.
2 – Say yes, keep analytical to the end, and appear as rough, cynical and insensitive human beings.
Fortunately for them, the fund manager, a nice guy, who knew this was a bit harsh for stressed young students, helped them out by rephrasing the question in a more escapable way. Something like “Do you really think that hard cost cutting on such a sensible business is good for the company on the long run?”. They somehow answered that and they all moved on.
But the very disturbing feeling stayed, and blurred the rest of the team’s performance.
They did not win. Another team was objectively stronger anyway. But I sure hope they did learn something during those few awkward seconds.
Financial analysis has become dehumanized, too technical
Because I definitely did.
I was already giving, and I am even more now, the students I mentor the same advise when preparing their report and presentation : “do not be overly technical, always think about the practical reality of the various human beings implicated. Employees, managers, clients, providers, they are what this is really about”. Sure, sure you need to create valuation models, assess various financial risks. You can also talk about costs and compute financial ratios. You can create impressive regressions and talk about macroeconomics… yes yes this is good (and the contest’s rules ask you to anyway).
But at the end all of this has no value whatsoever if you cannot link your findings to very material micro-economics reality. And when I say “micro-economics” I of course think “human” reality.
Being overly technical is actually easy, because you can easily prove that you have been diligent enough. That you worked and are competent.
But this won’t make you a good investor.
Think of it this way :
Human economic reality without financial analysis to support it is merely an opinion.
But financial analysis without human economic reality is merely an excel spreadsheet.
And this is the only way forward…
For a good 10 years now, index-tracking funds have gobbled up a very large chunk ( more then 30% in the US ) of the fund management business. And they are still on the rise. They do not try to apply any analysis in the investment, they are plain simple : they buy and hold the securities included in the index. That’s it. No analysis at all. And they are gaining more and more momentum. Machines.
Because active managers (i.e. traditionnal financial analysts) cannot reliably deliver over-performance anymore over the said indexes. As they have higher fees, they on average under-perform trackers. They might have in the past. But they are not anymore (on average). Don’t get me wrong, for the greatest part of them they are honest, competent and diligent professionals.
There are many explanations to their inability to overperform as a group, but one of the biggest is the number of investors that are applying the very same analysis methods at the very same moment, with the very same data available.
You guessed… it is huge (the number of Chartered Financial Analysts, the international standard for asset management, grew by a stunning 138.420 in the last ten years !). And they are all bright, well trained, and extremely technical young people.
Professional investing became so competitive that just relying on ratios and valuations models over past data that everyone have anyway just won’t cut it anymore.
Financial analysts now have to differentiate from each other to survive, they have to move away from the standardized models. Those models are widespread and the alpha of dehumanized financial analysis has been arbitraged away a long time ago, or at least it is so diluted now that it does not cover the fees.
They have now to add information to the analysis that they are the only one to possess, and that cannot be understood by robots. They need to add to the process new information about people, given by people. This type of information is disruption-proof for long, but requires analysts to get away from their office and excel spreadsheets, pick up their phone, test products, travel, read, talk, read, talk…
And when they are done talking, come back, understand that a business cannot run without its people and use financial analytics to link all of those people together in a meaningful way, an investable way.
The classic venture capitalist cliché is to say that they “invest in people not companies”. I would conclude by rephrasing this in a 3 part advise :
- They are right, we should always invest in people, not companies.
- But investing in people is not only about investing in skillful management. It is also about motivated employees, good suppliers, committed clients… and respect from the general public.
- Finally, analytics are indeed unavoidable, but are only useful if you feed them with original information this is a bit more meaningful than just “okay they reported a growing operational margin, and we are expecting this to continue because they said they would keep cutting costs”.
Investors, our work got a lot harder and competitive, so we need to leverage the edge we have over them. We need to leverage that we can understand what it is like to be an investor, lender, banker, manager, employee, worker, client, partner, furnisher, regulator, competitor… and having a mother.