Brokers get a bad rap. Even grandfatherly figures like Warren Buffett take the occasional jab. He once said there’s only one place in the world where people ride in a Rolls-Royce to get advice from those who take the subway. That place is Wall Street!
In movies, brokers are often portrayed as villains. The Wolf of Wall Street drives this message with a scene where Jordan Belfort is told that the goal is to ‘move the money from your client's pocket into your pocket.’ Much of the criticism is arguably a hangover from the days when brokers were incentivised to prioritise trading volumes over investors’ profits. Brokers earn commissions every time an investor makes a transaction, regardless of whether a stock rises or falls. So some brokers would ‘churn’ a portfolio — i.e. buy and sell excessively in order to drive up commissions. Wall Street’s history of scandals hasn’t helped their reputation, either.
That said, there may a case for being a bit kinder to brokers. Regulatory reforms now mean that brokers can no longer receive commissions from fund managers for investment advice. Moreover, their research reports offer insight, and qualitative analysis, which is essential tools for truly understanding a business. Brokers also provide market liquidity, ensuring trades can be executed without trouble. That’s all well and good, but let’s not forget the key question: Are brokers good at picking stocks? They stick great, big 'Buy', 'Hold' or 'Sell' recommendations on their research papers. Let’s explore whether investors should pay any attention to them…
Rage against the machine… or rage against the self?
Brokers undergo rigorous training. They have to pass challenging exams. But they are just human—only human—prone to general all-around messiness. Fund manager James Montier is an interesting case in point. He developed a tactical asset allocation model based on value and momentum rules. Montier delegated decision-making to his model, but there was a catch. He only listened when the model agreed with him. Initially, the model produced signals in line with the Montier’s own bearish outlook. Then the model gave bullish signals which contradicted Montier’s opinion. So of course Montier overrode the model. And of course the model outperformed Montier, who admitted: ‘I spent about 18 months being thrashed in performance terms by my own model.’
The story reminds me of Richard Brautigan’s poem, All Watched Over by Machines of Loving Grace. Brautigan paints a world where…
