Hi all. I posted earlier (about reflecting on six years following a career change) and got treated to a fascinating discussion -- thanks to the questions raised by all of you! In that discussion, some thoughts started germinating. I'm going to try to lay it out concisely here. And I of course welcome critiques, criticisms, reflections, and the occasional Monkey Poo (because what is a good discussion without Monkey Poo?)
If you're going out to sea, don't swim against the wave. Try to ride the wave. If you don't know where the wave is, build yourself the best boat you can.
Modern portfolio theory (MPT) is a way of maximizing your risk-adjusted returns in a given portfolio of equity securities. It is the heart of passive, index investing pioneered by the likes of Vanguard. To me, there are four compelling learnings from MPT:
- Passive investing has been shown over time to outperform the lion's share of actively managed investments, after management fees, transaction costs, taxes, etc. See Buffett's "long bet".
- "Beta" (underlying industry) determines >90% of portfolio volatility and that "alpha" (manager skill) determines <10%.
- It's not that you can't achieve alpha, it's just that a small fraction of managers do (Warren Buffett), and that an even smaller fraction can repeat that performance consistently over time.
- Those who achieve alpha usually do so not by having access to information or insights that others don't (eg. as a long-only hedge fund) -- but rather being able to act on that insight (eg. as an activist investor, or as a PE investor able to select a CEO)
I believe this has direct consequences for career planning as your skill set is your "capital" and your earnings are your "return on capital". So what does that mean? I would boil it down to four lessons, along the lines of the above.
1. Expected returns tend to converge over time
Thinking back to my MBA 5-year reunion, less than 5% of my classmates who had entered banking were still in banking. The rest had exited the industry (voluntarily or not) and most had taken pay cuts of various degrees. The "expected value" of earnings of people who had started out in banking and then exited the industry (95%, don't forget) combined with the astronomically higher risk of layoffs at that time converged with people who had taken consulting or even Fortune 500 jobs. Just as John Paulson made a killing in the aftermath of 2008, and then has been a total shitshow since -- earnings trajectory on an expected value basis followed a similar pattern.
2. Solve for "beta" and "asset allocation" (industry choice) rather than "alpha"
When I left banking in 2012, the industry was in the midst of a "false recovery", staffing up as if the glory days of 2007 were back, but without the deal flow and still dealing with new regulations. As a result, even the best bankers were being shown the door left and right, and with multiple rounds of layoffs every year, you couldn't count on having staying power. Moreover, you couldn't even try to "time the market" because you can't exactly defer or accelerate your MBA graduation.
In that environment, my "alpha" (or individual performance) was completely subsumed by industry "beta" (underlying characteristics). I could have been the best Associate in the world (I wasn't!), and still my fate was determined by industry dynamics rather than my personal performance. In that case, I chose to change my "beta" and adjust my "asset allocation" by switching industries rather than trying to outperform.
Put another way, even if you got the best offer imaginable, would now be a good time to join, say, a plain-vanilla cash equities trading desk?
3. Aim high and be ambitious -- but don't bank on it.
We've all heard glory stories of the obscenely wealthy MD or PE partner. I'm sorry to say it but chances are, you will in all likelihood not become that guy. This has nothing to do with you and your personal performance. It's just that your personal performance often has very little to do with your career trajectory (see comment on "beta" above). In 2008, the very best and brightest of mortgage bond salesmen were screwed. Meanwhile, in 2017, a bunch of idiots trading cryptocurrency became overnight millionaires. Very little is fair in life, and market volatility and the "unknown unknowns" play a much larger part of shaping outcomes than your personal efforts.
4. Solve for skills and people, rather than roles and prestige
I can't describe how much the people I've worked with have mattered to my career. If you are joining investment banking as a young analyst, go with the group that's taking a genuine interest in your career and will commit to sponsoring and mentoring you, not the group that is hot in today's papers. If it's hot in today's papers, it (and by extension you) risk become yesterday's news tomorrow. But people who will commit to sponsoring and mentoring you stay there year in and year out. To this day, I regularly keep in touch with my buddies from my first posting on the Street.
As for skills, my comment above is that managers who do generate "alpha" tend to do so via governance or management value-add, not passively mining information in the hopes that nobody else has realized the stock is underpriced. Think about it. Up through VP, a job at an IB is essentially a role in mind-numbing process management -- how to create PowerPoint decks, coordinate Excel spreadsheets, and project-manage a group of overpaid, sleep-deprived PowerPoint artists and Excel jockeys.
No wonder VPs have trouble finding decent-paying exit roles, because who in the right mind would pay for that skill set? They don't have other marketable skills that might justify a higher paycheck (for example, ability to be a P&L leader of hundreds of employees). I don't regret my time in banking at all because it taught me how to present well, how to model well, and how to have a corporate finance view of the world. But had I stayed any longer, that's all I would have. Not how to set ambitious goals, how to have performance dialogues with employees, how to motivate your people, how to counsel senior executives, as well as meatier "content" roles like how to run a strategic account planning process and upskill the 2nd and 3rd quartiles of a salesforce, or how to pick best athletes and map functions as part of a merger integration. The latter skills I would not have learned in banking, but do make me more marketable.
To go back to my TL;DR: if you're going out to sea, don't swim against the wave. Try to ride the wave. If you don't know where the wave is, build yourself the best boat you can.
That's it! Comments welcome. And by the way, this is a theory in progress, so always open to changing it.