Drinking the Kool-Aid

When I worked for a hedge fund on Wall Street a common term among the equity analysts was “drinking the Kool-Aid”. They used the term to describe other analysts who believed the b.s. that the management of covered companies would spew during conferences or meetings. Of course, they didn’t refer to the term when they believed the spew from their favorite companies nor did they refer to the term when describing their own job.  I quickly realized the futility of picking winning stocks and I began to wonder whether other analysts actually believed that they could pick winning stocks (drinking their own Kool-Aid) or did they realize that they could not and just did their job because of the fat fees they could skim off of deluded investors?

Which is worse? An investor that is too stupid to realize that beating the market is a fool’s game or one who realizes this but is dishonest enough to still take investor money? You can be the judge of that but the question remains which of the two scenarios is true?

An article in the Wall Street Journal answers this question, at least for one analyst who runs his own hedge fund. Paolo Pelligrini was an analyst for hedge fund manager John Paulson who made billions by betting against the housing market during the bust (he actually bet against the packaged mortgage products). Pelligrini was the analyst who helped Paulson structure the bets that resulted in the windfall. He grew rich because of this and then went off and formed his own fund, but he invested a large amount of his wealth in one of Paulson’s funds, and was badly burned. He drank the Kool-Aid and believed that he and Paulson could actually consistently beat the market.  The market proved otherwise. He should have taken his luck provided windfall and turned to index funds. He was taught an expensive lesson. Don’t make the same mistake.