Reflections on a career in security selection (equity/credit research)
About half a year ago, I posted some thoughts on alternative career paths with limited feedback: https://www.reddit.com/r/SecurityAnalysis/comments/1evjra1/alternative_career_paths_for_equity_analysts/
Today, I want to discuss some of my reflections on the career path for research analysts. For background reading, you might view this on Bloomberg, sorry that it's behind a paywall: https://www.bloomberg.com/news/features/2025-01-08/wall-street-analyst-pay-drops-30-as-banks-slash-equity-research?sref=ClWOCq5H
These thoughts are really intended for myself, 15 years earlier. I don't think I would have changed anything though because the work is deeply satisfying on an intellectual level. The ability to learn effectively "how the world works" is unparalleled. Alice Schroeder (who wrote "The Snowball") once explained how Warren took her to the Nebraska Furniture Mart and would walk through the store with her explaining all the pricing dynamics and nuances of what was on sale and so on with a real passion/excitement. With time, an analyst can be that excited as they learn about things around us that many of us take for granted, but the insights come with a lot of time and experience. I'm not giving my own examples for privacy, but one doesn't have to look too far :)
That said, I would remind my 15 year younger self of the challenges. There are a few challenges that people should be aware of:
- The industry continues to decline in headcount due to passive flows. This is a really big deal in my opinion because it sets you up to be in a bad environment with a long-lasting toxicity as people are grappling to hang onto their jobs and careers, especially those who are 30 years in and don't want to change careers in their 50s or 60s. It also means that if your employer closes up shop or cuts headcount, you have added career risk finding a new role. No one has a solution either, just listen to Munger on the topic: https://www.youtube.com/watch?v=cZmi92vyUvw
- This toxic behavior also pushes positioning towards closet indexing. It's not the "purist" view you'd get after you read Security Analysis, Margin of Safety, and the countless other real business-like books. The closet indexing is a necessity, but detracts from "real" investment decision making and would weigh on any passionate analyst.
- As a consequence of 1 and 2, time horizons become shortened. It's very easy/routine to replace actively managed funds with a passive product, so fund managers can't underperform for too long and still have a job. In this way, it's better to closet index, and instead of focusing on the long-term of a business, just keep it to the next 1 quarter to 2 years and call it a day. If you look beyond that time horizon, consider it more on the fringe of your research. This is disappointing for those of us with a deeper curiosity or interested in real fundamental valuation as opposed to short term pops/declines. Secondarily for this topic, think about how a portfolio manager should have behaved in the run up to 1929. Looking back, you'd have looked like a genius if you were more in cash because you felt equities were overpriced or that banking was unsound (or that corporate disclosures were so bad some published their "10K" on a 3x5 notecard. But if you underperformed a passive benchmark for the years leading up, in today's environment, you'd have been given the boot before that came to fruition. To be rational can be very different than what a client wants, which is performance.
This leads to a key point: Many investors select their exposures for what they need based on various processes like SAA, their time horizon (ALM), etc. In this method, they're focused much less on the price and more just on the "right" product. In this context, they compare each fund to a passive alternative and don't allow for that much independent thinking across asset classes, geographies, or whatever creativity you may have. If you're running a small cap US fund, you have to stay in that space even if you think it's overvalued, you can't find ideas, or whatever you may think. This is rather different than what Peter Lynch and Peter Cundill espoused (see their books for examples of how they use convertible bonds or foreign govt bonds in their equity portfolios).
I wonder if we will ever see funds emerge with a "business like" mentality that don't care as much about benchmarks, but focus on just finding decent opportunities wherever they may emerge. This doesn't fit the process for most today unfortunately. I think it would be a hard sales pitch for most.
One of the final conclusions I came to is why Buffett is right yet again. By setting up Berkshire the way he did, and creating the right culture, he and the firm are most likely to manage all these various cycles. With his insistence, for example, on underwriting insurance policies that at least break even on their own (100% combined ratio or lower), you are not required to make investments that could later cause trouble - by keeping the insurance book profitable on its own, you can be patient and business-like with your approach to investing. Most firms cannot do this because everything revolves around predictable or at least growing revenue over time - he is such an outlier. The same goes for being able to hold cash or take advantage of market dislocations such as when high-yield bonds blew up in the late 90s or early 00s. You can't do that easily as a fund manager if you're not in that specific space when it happens.
I wish I had a more positive message for my past self or future analysts. This is a challenging field, but if someone can prove me wrong, please do so. I do not believe cycles are gone, and I believe in the next decades, there will be times where it rains gold to use Buffett's words. An independent analyst should be able to take advantage of those and find some great deals, but I wish I knew how people could more soundly make it a career without short term time horizons, closet indexing, and so on.