Throughout my career, I have helped train and mentor a number of aspiring portfolio managers. Many find themselves prepared for various technical aspects of the job i.e. how to trade certain products, how trades settle, how to calculate risk, how to build a portfolio, how to manage stop-losses etc. In my opinion, these technical skills will not be the biggest problem faced on the journey, but rather the emotional issues that accompany it and sadly most people do not enjoy that aspect of the job.
For most becoming a portfolio manager is not a good career choice, but for a small number it is perfect. Therefore, one of the things I try and help aspiring managers to understand is the different stages they will pass through.
Stage 1 – Observer
This is the stage where people have shown real interest in financial markets. They follow the news, read analysis, develop their technical knowledge and skills, and enjoy forming market views and expressing them to others.
A common error for an aspiring PM is to think this stage is a long way along the road. A key element is the lack of clear feedback mechanism; or rather feedback is likely to be qualitative (perhaps social i.e. do people like what they say and write) but unlikely to be quantitative or objective.
Stage 2 – Paper trading
This is a helpful stage that I push aspiring PMs towards – I explain that this is what I did myself. My observation is that those who will become successful PMs will have already done this sort of activity on their own. After all who could stop them?
Paper trading is the stage where people can realise if they care enough about forming views and narrative about financial markets, or care about playing a game in which you keep score by how many dollars you gain or lose. Paper trading becomes engrossing because it is an active feedback mechanism on your decisions and thus the only way you could ever improve. All I do at this stage is help them think about trading and how to evaluate their decisions for themselves. The key is that only those that enjoy it and like keep to score in an honest way, can actively progress from here.
Most aspiring PM’s actually stop at this stage and soon revert to stage 1. Some get bored, some use their paper portfolio as a means to signal their “view” e.g. bullish the Australian dollar, much like a research strategist does. The preference to talk about trades where they were “right” often becomes dominant, rather than all the other lessons they learnt. If I point out that their overall paper portfolio has lost money they will often blame “money management” or “risk management” as though this is some technical add-on that is of secondary importance to their view formation.
Stage 3 – trading real money (small)
At this stage, aspiring PMs are often shocked to find out how much worse they perform than when they ran a paper portfolio. To the outside observer, it may appear identical, but for the participant I would highlight these key differences:
It is public
Actual P+L in a firm will be reported. In a paper portfolio you are free to make any decision you want and the only person who will ever know about them is yourself. Once real money is at stake, all your decisions are visible, and can be can be looked at much later by other people who will judge them. In this respect it is similar to my very first blog post “How to Write“, your thought process will change in the same way that writing in a private diary is different from an essay submitted to a teacher.
It is real money
I remember being really stressed at this stage in my career, partly because I was so bad at it! I kept losing money. It felt real to me. I would lose perhaps $500 on an FX trade and this felt like a lot of money. I could buy a TV for that. I struggled to understand why my bosses were so relaxed and tolerant of me throwing the firm’s money away. Later once I was the manager I understood that this is a cost of training and most people really struggle at this stage.
It matters for your career
This is especially tough as you are starting to take risks with your future. You need to persevere, building up evidence to convince people to give you more money to trade. It is hard to predict who will make this transition and who will fall back into the far more numerous careers in stage 1.
Stage 4 – trading real money (large)
By the time you get to Stage 4, the vast majority of aspiring PMs will have already fallen away. This does not mean that you are now the finished article and that it will be easy from here. Once you start managing larger amounts of money you will face different stresses.
Now your trading decisions will have a material impact on your life and career. If you do really well you will get a large bonus, buy a flat and a nice car. If you do not, you may get fired.
It is starting to be too late to simply go back to Stage 1 and find another path in finance (unlike at stage 3). Here you will be highly vulnerable to Desirability Bias (Desire – The Fatal Flaw). You will want to make good decisions really, really badly. You will really, really want the decisions you have made to be good ones. This can damage the delicate cognitive processes that are required for nuanced decision-making.
Some people struggle here and effectively behave as though they are still in Stage 3. They will take small risks and although they enjoy trading and are good at it, they cannot commit to risking their job and livelihood based upon it. For some reason, I loved this stage. I felt freed up from the restrictions of Stage 3 and had huge (over)confidence in my ability. In hindsight, I still had an awful lot to learn but my confidence and ambition kept me moving forward.
Stage 5 – full-time portfolio manager
Here there is nowhere to hide. Managing money is not just a part of your job – it is everything. The decisions you make will determine whether you can buy the nice house, pay for your kids to go to private schools, what lifestyle you can afford and more broadly your status in society.
My sense of this stage is that the people who really care about money, in the sense of what it can buy you, do not become portfolio managers. There are many safer and more reliable routes in finance to get those things.
The ones who do better are perhaps more like me. I did not care very much about leading a very affluent lifestyle, I had earned enough money in my career not to worry that I would end up in severe financial stress and so leaving the relative security of running a business in a bank did not feel very risky.
Conclusion
What I find striking is how hard is it to predict who will succeed at the various stages.
The people who were outstanding at Stage 1 might be complete failures at Stage 3. Those who were very good at Stage 3 would not come across anywhere near as well as the analysts and strategists in terms of their ability to talk about markets, economics and strategy.
Those who were successful at Stage 3 generally focused on the task at hand (i.e. find something, anything which they could turn into making a profit.) This might mean they became an expert in a tiny section of a market and thus needed to know nothing at all about unrelated areas of finance and broad market drivers. It is the focus on making money that is far more important than a broad interest in financial markets.
To become a portfolio manager, not only do you have to refine your technical ability, you will need add emotional strength to deal with the challenges. This can be even harder to predict.
Applied Macro 