The Fiduciary Nature of Financial Storytelling
Written by Angelo Calvello
Professor David Tuckett notes that “there are few human institutions more alien to our understanding” than financial markets.
It is our job as financial marketers to make these alien markets understandable to allocators. More specifically, it is our professional mission to explain to clients and prospects how our firms and investment processes can consistently provide the promised returns given the unpredictability and randomness of the markets in which we invest.
To fulfill this mission, we construct narratives that distill our increasingly complex investment decision-making processes into a sequence of causes and effects, expressed in the common language of investing.
Critically, our objective is not to merely explain our processes but to create narratives that provide allocators with sufficient conviction to act in a particular way, i.e., invest in our strategies.
However, while we are storytellers, we are first and foremost fiduciaries and we construct our narratives to convince other fiduciaries to act in a way that benefits both their missions and our firms. We therefore should ensure that our narratives are truthful and that they accurately and plainly explain the investment decision-making process by which we generate returns.
This obligation presents us with several inimitable challenges.
To start, we must acknowledge that we are prisoners of our character, circumstances, and commercial interests and that as storytellers, we manufacture our narratives out of whole cloth–we choose what to include in the narrative and how to structure and express this content.
Our first decision is often one of omission: investment narratives willfully omit the most critical feature of the investment process–the part that explains our edge or “secret sauce.” Allocators have been falsely conditioned to accept this omission as a necessary part of the narrative, yet they do expect our descriptions to include enough salient details that they can make an informed decision. Our job is to strike this balance between transparency and opacity.
Second, given this deliberate omission of this key feature, we must make every effort to communicate the remaining details in clear and easy-to-understand language. The Financial Times’ Robin Wigglesworth writes that managers “love pseudo-philosophical metaphors and references, especially if they are recondite.” Such a deliberate choice of language adds another layer of opacity, further concealing the truth about our processes.
Third, we must recognize that even the most transparent narratives are deficient because they hugely (but not necessarily intentionally) understate the role of randomness in our investment processes. What we might present as a causal relationship between an action and a result simply might be the results of a chance occurrence, so, borrowing a phrase from Nassim Taleb, we are often fooled by randomness.
Fourth, we must be careful not to conflate data to support a particular story. For example, recent research “identified a group of US-domiciled institutions who join the PRI initiative but do not follow through on their commitments. These US investors either report that they do not incorporate ESG issues or do not report on their ESG incorporation efforts at all. Hence, these US institutions are fundamentally uncompliant with Principle 1 of the PRI (‘We will incorporate ESG issues into investment analysis and decision-making processes). They also have significantly worse portfolio ESG scores than non-PRI institutions, which is also inconsistent with the principles.”
It would be duplicitous and disingenuous for such a non-compliant manager to use its PRI membership to demonstrate its ESG bona fides.
Finally, the late Joan Didion writes in her essay, The White Album, “We tell ourselves stories in order to live.” This is especially true when things go wrong. And in our business things often do go wrong. Alpha is scarce, transitory, and capacity constrained so there will undoubtedly be times when despite our best efforts, a struggling investment strategy can no longer be expected to produce the promised returns.
Third Point CEO and CIO Daniel Loeb makes this point abundantly clear in his first-quarter 2022 investor letter:
We create data-driven stories to explain our differentiated view of security that is out of balance within its sector or asset class to justify a variant perception that we think will generate alpha. Sometimes, however, investors might create a framework that seems sound only to discover that the method is actually no better than a system to “win” at Russian Roulette. The key, of course, is to change your framework when the environment changes. Even the most sophisticated quant investors employing hundreds of Ph.D. mathematicians and physicists find that their models can fall short due to the ever-changing topography of the surface area of relevant data.
It is critical that we rewrite our stories to include and reflect this new information. And because when we craft our narratives, we work hand-in-glove with our investment and compliance colleagues, it is imperative that we adopt an active and discriminating posture in this iterative process to ensure their veracity.
The recent Securities and Exchange Commission (SEC) case against Allianz Global Investors U.S. LLC provides a chilling and cautionary tale for financial marketers who do not adhere to this imperative.
On May 18, 2022, the Securities and Exchange Commission (SEC) “charged Allianz Global Investors U.S. LLC (AGI US) and three former senior portfolio managers with a massive fraudulent scheme that concealed the immense downside risks of a complex options trading strategy they called ‘Structured Alpha.’ AGI US marketed and sold the strategy to approximately 114 institutional investors, including pension funds for teachers, clergy, bus drivers, engineers, and other individuals.”
You can read the appalling details of the charges here, but the SEC alleges that the narrative used to sell this strategy deliberately misled investors not only about the performance of the strategy (“Defendants reduced losses under a market crash scenario in one risk report sent to investors from negative 42.1505489755747% to negative 4.1505489755747% — by simply dropping the single digit 2.”), but also about AGI’s failure to supervise of the strategy (Chief Investment Officer Greg Tournant “touted the protections provided by the funds’ position within the global Allianz corporate structure, calling Allianz a “master cop” that would ensure that Tournant followed the risk guidelines promised to investors. Despite Tournant’s claim that Allianz acted as a “master cop” looking over his shoulder, no one at AGI or Allianz was verifying that Tournant and his colleagues were actually adhering to the investment strategies promised to investors.”)
AGI’s and the investment team’s was “an egregious, long-running and extensive fraud that went undetected for years…one that accounted for 25% of AGI’s revenue in recent years, which amounted to hundreds of millions of dollars.” This naturally raises the question of what role, if any, AGI’s sales and marketing teams played in perpetuating this fraud.
In the end, our singular responsibility as marketing and sales professionals is to always put the interests of our clients first and create and tell the real story, even if it is not a story we might not want to tell.
Angelo is the co-founder of Rosetta Analytics, an investment management firm that uses proprietary advanced machine learning to build and manage investment strategies for institutional investors. Before starting Rosetta, he co-founded and served on the board of Blue Diamond Asset Management AG, a volatility hedge fund based in Zug. Angelo has held senior positions at Man Investments Inc., State Street Global Advisors, Crédit Agricole Futures, and the CME Group. He also served as CIO of a family office in the Chicago area. Angelo started his investment career as an independent floor trader at the Chicago Board of Trade and the Chicago Board Options Exchange.
Currently the “Dissident” columnist for Institutional Investor, Angelo is a former contributor to CIO Magazine, where his regular column, “The Doctor Is In,” won the American Business Media’s 2016 Jesse H. Neal Award for best commentary. He is the author of Environmental Alpha: Institutional Investors and Climate Change (Wiley 2011) and the founder of the Journal of Environmental Investing (www.thejei.com).
Angelo earned a PhD in contemporary European philosophy from DePaul University. Angelo serves as a trustee and Vice-Chairman of a Chicago-area police pension board and is a member of the Chicago Quantitative Alliance.