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The Wizard of Wall Street

Like a lot of people who end up on Wall Street, Blaine Lourd just sort of stumbled in. He'd grown up happy in New Iberia, La. His father had made a pile of money in the oil patch, and Blaine assumed that he too would one day eat four-hour lunches at the Petroleum Club, hunt ducks on the weekends, and get rich.

Blaine felt right at home in Louisiana right up to the moment when, during his third year at Louisiana State University, the price of oil collapsed and took the family business with it. His father, after informing him that there was no longer a family business for him to inherit, suggested that his ability to get people to like him might go far on Wall Street. "I didn't know what Wall Street was," he says. "I didn't even know where Wall Street was."

Really, he just wanted to be a success. How that happened, he didn't much care. So in 1987, at the peak of the bull market, he was in a Shearson Lehman training program, which focused mainly on overcoming customers' objections, and a close reading of the bible on how to peddle stocks to people you've never met: Successful Telephone Selling in the '80s.

A well-planned presentation creates a sense of urgency. If the prospect fails to act now, he will risk a loss of some sort.

Speak with confidence and authority.

The most important part of the presentation is the close.

Blaine set a goal for himself: Reach 100 people a day by telephone. Half the time, people hung up on him, but about one in every 300 calls led to a sale. He arrived at his office at 6 every morning to make sure he got the best lead cards. He was paid on commission and driven by fear of failure. "There were a lot better salesmen than me," he says. "I just worked harder. I made more calls. And if you make more calls, you will get the sales. And it doesn't matter what you say."

Most of the time, he just read from the same script as the other brokers: "Are you familiar with Warren Buffett? We have information from our sources on the Street that his next position is going to be in a company much like Cadbury Schweppes. (Pause) I know you're busy, but I'd like to call you once or twice in the next six months when we have a substantial idea that will make you three to 10 times your money."

When Blaine would call back 10 days later, it almost didn't matter what he said, as long as he demanded an order and then fell completely silent. "Mr. Johnson, this is Blaine Lourd from Lehman Brothers. We see Abbott Labs going to 60, and I think you need to buy 10,000 shares of Abbott Labs today."

Half the time, in the ensuing silence, Mr. Johnson would hang up. But the other half, Mr. Johnson would explain, usually pathetically, why he couldn't right then and there buy 10,000 shares of Abbott Labs. And once Blaine had a specific objection, he had an obstacle he could overcome.

I've got to talk to my wife.

"Mr. Johnson, if you're driving at night with your wife in the city, it's snowing, and you have a flat tire, do you ask your wife to go out and change it?"

I don't have the cash.

"Mr. Johnson, you have stocks in your portfolio that are underperforming. We'll take you out of them to get you into Abbott Labs."

Why Abbott Labs?

"We have it on good authority that it's Warren Buffett's next purchase."

The older brokers in the office all threw around Buffett's name, so Blaine did too. Buffett was useful because everyone knew who he was and everyone thought he had made his money picking stocks. Blaine was picking stocks just like Buffett but using different criteria. The traders in New York would accumulate a block of shares, driving the price up, and then get brokers like Blaine to unload the shares quickly at the higher price — whereupon the price would, often as not, fall. "Seven months in at Lehman, I was one of the top rookie producers," Blaine says. "But every stock I bought went down."

His ability to be wrong about the direction of an individual stock was uncanny, even to him. At first, he didn't understand why his customers didn't fire him, but soon he came to take their inertia for granted. "It was amazing, the gullibility of the investor," he says.

It wasn't exactly the career he'd hoped for. Once, he confessed to his boss his misgivings about the performance of his customers' portfolios. His boss told him point-blank, "Blaine, you're confused about your job." A fellow broker added, "Your job is to turn your clients' net worth into your own." Blaine wrote that down in his journal.

Then he caught a break. He met a girl who liked him. The girl went and told a friend about him. That friend was the business manager for the Rolling Stones. One thing led to another, and the Rolling Stones handed him $13-million to invest. It was that easy. This money constituted their tour fund, and they didn't want to take any risks with it. "I went to my office manager and asked, 'What do I do with this?' And he looked at me and said, 'I dunno.' "

Blaine was seriously unnerved: He knew how to sell stocks to strangers, but that skill had nothing to do with preserving a pile of capital. "All of a sudden, I got a real client," he says. "It wasn't from some cold call. I didn't want to lose the Rolling Stones' money." He decided to invest it in Treasury bills.

"Right away, I'm in conflict with the firm. My colleagues gathered around this money and asked me, 'How are you going to gross this thing up?' " Meaning how would they be able to maximize their commissions. "And I said, 'What do you mean? It's in T-bills.' And they said, 'We can't make any money on this.' And that's when I said to myself, I gotta get out of here."

He quit Lehman Brothers and took a job at the Los Angeles office of Bear Stearns. But Bear wasn't any better. The nicest thing he could say about himself was that he hadn't broken the law. He hadn't bankrupted anyone or anything like that. But when he stepped back from his job and really looked at it, he realized that a huge amount of his time and energy went into making people feel happy about his advice when they should have been furious.

The problem was the constant tension between company and client, caused by the firm's inability to know what the market or any particular stock was going to do next. "It was the same everywhere," he says. "It was all about getting people to transact." And these weren't bucket shops; they were Wall Street's most distinguished firms.

He was a 29-year-old earning $200,000 a year, and he was, as he puts it, "ramping up the lifestyle." Rival firms noticed his success: He left Bear Stearns for Dean Witter, which would later become Morgan Stanley. Blaine's business grew to the point where he became somewhat famous. Name a prominent director or big-time movie star, and there was a fair chance that Blaine Lourd was giving her financial advice. He lived near the beach in Malibu, drove fancy cars, and indulged an expensive taste for young women who had moved to Los Angeles to become movie stars. He routinely ranked in the top 10 percent of revenue producers for whichever firm he happened to be working for. In his best years, he grossed more than $1-million. His father had been right: His persuasiveness and ability to get people to like him went far on Wall Street.

Only now he had a problem. He was quickly becoming the world's unhappiest man. He often woke up with a sinking feeling in the pit of his stomach; more often, he woke up with a hangover. Like a lot of his fellow stockbrokers, he started drinking too much. "You can't continually hurt people," he says, "and feel good about yourself."

One day, he woke up to find he was a 37-year-old late-1990s cliche: the self-loathing Wall Street salesman. One day, someone may look back and ask: At the end of the 20th century and the beginning of the 21st, how did so many take up financial careers on Wall Street that were of such little social value? As a group, professional money managers control more than 90 percent of the U.S. stock market. By definition, the money they invest yields returns equal to those of the market as a whole, minus whatever fees investors pay them for their services. This simple math, you might think, would lead investors to pay professional money managers less and less. Instead, they pay them more and more. A vast industry of stockbrokers, financial planners, and investment advisers skims a fortune for themselves off the top in exchange for passing their clients' money on to people who, as a group, cannot possibly outperform the market.

In Santa Monica, as Blaine twisted himself into ever more intricate knots to disguise his inability to pick winning stocks or money managers, his antithesis was rising. It was a firm founded in 1981 on a simple idea: Nobody knows. Nobody knows which stock is going to go up. Nobody knows what the market as a whole is going to do, not even Warren Buffett. A handful of people with amazing track records isn't evidence that people can game the market.

The firm, Dimensional Fund Advisors, was co-founded by David Booth, who had worked at the University of Chicago as an assistant to Eugene Fama. As a graduate student in the early 1960s, Fama coined the phrase "efficient markets." DFA sold its clients on passive investing: Instead of looking for trading opportunities and paying stockbrokers and fund managers, DFA bought and held baskets of stocks chosen for the sort of risk they represented. It didn't call these baskets index funds, but that is more or less what they were. In the summer of 2007, when I visited, the firm had an astonishing $153-billion under management.

DFA requires its aspiring anti-salespeople to fill out questionnaires and submit to telephone interviews. If they pass those tests — which thousands fail — a team from the firm would then dignify them with an office visit and grill them on their beliefs about the stock market. The final test of ideology is the conference.

The day I arrive at DFA's offices, I find 150 financial advisers in a glass box, waiting to be educated in a seminar that lays out the DFA way. The atmosphere is entirely different from Wall Street. There's no chitchat about the market, even though it has been bouncing around wildly. Instead, two speakers discuss how, knowing what we now know, anyone could present himself as a stock-picking guru. "If you put a thousand people in barrels and push them over Niagara Falls," one of them says, "some of them will survive. And if you take those guys and push them over again, some of them will survive. And they'll write books about how to survive being pushed over Niagara Falls in a barrel."

The people in the room are all salesmen, but salesmen peddling an odd idea: Don't listen to salesmen. DFA financial advisers must never, ever, sell individual stocks, try to time the market, or suggest to investors that it is possible to systematically beat the market.

What makes someone good at selling this curious attack on the modern financial system? I ask Joe Chrisman, the interface between DFA and the thousand independent financial advisers who have qualified to sell DFA funds, "Of all these proselytizers, who is the most effective at taking an investor who thinks he can beat the market and turning him into someone who quits trading and hands his money over to DFA?"

"That's easy," he says. "Blaine Lourd."

A dozen years ago, Blaine bought a book an older broker recommended — Winning the Loser's Game — and took it with him to Aspen on his Christmas vacation. There, on the first page, he read, "Investment management, as traditionally practiced, is based on a single basic belief: Professional investment managers can beat the market. That premise appears to be false." Essentially, the author Charles Ellis argued, there was no such thing as financial expertise. "I read this book," Blaine says. "And I thought, My whole life is a lie, and everyone around me is facilitating this lie."

It took him stints at three firms to figure out that Wall Street wasn't going to let him act on his new conviction. He was no longer cynical; he was outraged. At the end of every year, he'd circulate memos showing that 80 percent of the money managers the firm promoted to clients had underperformed the market.

In June 2006, he quit A.G. Edwards and set up his own office in Beverly Hills. He called his new firm Lourd Capital Management and started doing from outside the established Wall Street structure what he had tried to do inside it. All but a handful of his 200 clients at A.G. Edwards left with him. He cast about looking for a home far away from Wall Street where he could put his money. And he remembered a friend telling him about DFA. That's when he learned that he couldn't join the new religion until he proved the sincerity of his faith.

In the early 1960s, the efficient-markets hypothesis took off, thanks first to Paul Samuelson, who reminded everyone of a dense thesis written in 1900 by a French graduate student named Louis Bachelier; the Frenchman called it the Theory of Speculation, in which he concluded that prices follow a random walk — that is, no information about past prices enables a trader to predict future ones. Then Eugene Fama tested Bachelier's theory against actual U.S. market data. Fama discovered that the Frenchman had got it exactly right back in 1900: A person could learn no useful information about future stock market prices by examining past performance. Chart reading, graph plotting, momentum analysis, and all the rest of the more esoteric Wall Street techniques for predicting stock-price movements were hokum.

Fama went further: No public information at all is of any use to a trader trying to beat the market. Balance-sheet analysis, industry insight, articles in the Wall Street Journal, a feel for the character of a CEO — these are all a complete waste of the investor's time, as what's already known is factored into stock prices too quickly to act on it, and what isn't known is inherently unpredictable.

The essence of the randomness message was that investors must simply accept the miraculous God-given returns of the stock market as a whole and resist the temptation to try to exceed those returns. They must never believe they possess special wisdom and judgment; the stock market has no use for human wisdom and judgment. And what about investors who systematically beat the market? Fama insisted that they simply don't exist. If millions of monkeys throw a bunch of darts at the Wall Street Journal, at least one monkey would pick a group of winning stocks.

Now in his late 60s, Fama serves as a consultant to and board member of DFA, where his main role is to buttress the convictions of each new platoon of financial advisers and reinforce the idea that investors who try to pick stocks or time markets are fools. Forty years of preaching has taught him that his audience either agrees with him or never will. And so he speaks dully, like a man talking to himself. But he makes his point. In his years of researching the stock market, he has detected only three patterns in the data. Over the very long haul, stocks have tended to outperform bonds, and the stocks of both small-cap companies and companies with high book-to-market ratios have yielded higher returns than other companies' stocks.

These are the facts. The question is how to account for them. Fama's explanation is simple: Higher returns are always and everywhere compensation for risk. The stock market offers higher returns than the bond market over the long haul only because it is more volatile and thus more risky. The added risk in small-cap stocks and stocks of companies with high book-to-market ratios must manifest itself in some other way, as they are no more volatile than other stocks. Yet in both cases, Fama insists, the investor is being rewarded for taking a slightly greater risk. Hence, the market is not inefficient. Everything else in the stock market he dismisses with a single word: noise.

There is an obvious question, one that no DFA financial adviser dares ask: If all financial advice is worthless and the only sensible strategy is to buy an index fund that tracks the market, why would anyone need a DFA financial adviser? Why, for that matter, should anyone pay DFA the 50 basis points it takes off the top of its oldest fund? DFA's answer to this is interesting: It can beat the index. The firm doesn't ever come right out and say, "We can beat the market," but over and over again, the financial advisers in attendance are shown charts of DFA's large-cap funds outperforming Standard & Poor's 500-stock index and DFA's small-cap fund outperforming the Russell 2000.

In each case, the reason for DFA's superior performance is slightly different. In one instance, DFA found a better way to rebalance the portfolio when the underlying index changes; in another, it came up with improvements in capturing small-cap risk. All these little opportunities can be (and are) rationalized as something other than market inefficiency, but they are hard to exploit, even with the help of DFA. The lesson of efficient-markets theory is that when anyone from Wall Street calls you up with financial advice, you should be very afraid. But it isn't fear that prompts investors to embrace DFA. It's greed.

"It was a propaganda session," Blaine says, groping for the best analogy to describe DFA's seminar. "It was beyond A.A. It was Leni Riefenstahl, but the right way." They weren't teaching him; they were deciding whether he believed what he needed to believe to sell their investment advice. This was new.

A couple of months after attending the seminar, Blaine succeeded in getting $100-million of clients' money into DFA's funds. He worked from his own little space in Beverly Hills, which was, in its most recognizable feature, as unlike a Wall Street brokerage firm as could be: It was completely silent. No TV blaring CNBC. No squawk box. No urgency. "There's one decision," he says. "We decide how much to allocate to various funds, and then we're done."

Last year was, by far, the biggest year of his career. The assets under his management are up 40 percent since he left A.G. Edwards. He's still making money, but clients come to him so he can prevent them from listening to tips — or hunches, or the latest rantings on cable TV. His biggest problem is new prospects. "The first question out of their mouth is 'Who's your guy?' We have to re-educate them: There is no guy. The guy is the market. The guy is capitalism."

His job, as he now defines it, is to tell investors that the smartest thing they can do is nothing. For that, he takes between one-half of a percent and 1 percent annually, which is more than they'd pay if they simply bought index funds on their own. "I tell them, 'Look, if you can control your own emotions and you want to go to Vanguard, you should do it.' And every now and then, someone asks the question, 'Why do I need you, Blaine? What are you doing?' And I say, 'Howard, be careful or I'm going to send you back to Smith Barney.' And they laugh. But they know exactly what I mean."

Blaine seems for all the world like a man who has made a separate peace. There's a hitch, though. Like a reformed addict or an escaped prisoner, he's now defined by what he isn't rather than by what he is.

"In a perfect world, there wouldn't be any stockbrokers," he says. "There wouldn't be any mutual fund managers. But the world's not perfect. In Hollywood, especially, people need to believe there's a guy. They say, 'I got a friend who made 35 percent last year.' Or 'What about Warren Buffett?' "

Then he pulls out a chart. He graphs for me the performance of one of DFA's value funds, which consists of companies with high book-to-market ratios, against the performance of Warren Buffett's Berkshire Hathaway since 1999. While Buffett's line rises steadily, DFA's rises more steeply. Blaine's new belief in the impossibility of beating the market doesn't just beat the market. It beats Warren Buffett.

Michael Lewis wrote the book The Blind Side:

Evolution of a Game, which was excerpted in Perspective as the story of "Big Mike." He also wrote Betting on

Disaster, which appeared in these pages last fall.

The Wizard of Wall Street 03/15/08 [Last modified: Tuesday, March 18, 2008 5:15pm]
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