16th August 2012
Teleb has published a new paper entitled Why It is No Longer a Good Idea to Be in the Investment Industry; as the Wall Street Journal reports:
"He says many of the best money managers earn their success based on "spurious performance" and these folks "rise to the top for no reasons other than mere luck, with subsequent rationalizations, analyses, explanations and attributions."
"Once they are at the top, though, they get the bulk of the allocations, creating a "winner-take-all effect" that causes distortions in the marketplace, he says."
His argument rests on the idea that investment management has a ‘spurious tail' – those who have attracted assets by luck rather than judgement. The difficulty of competing with this spurious tail, means that, for Taleb, wannabe investment managers may be better off diverting their talents elsewhere.
Taleb's attack comes at a time when parts of the investment management industry were already under fire. Veteran fixed income guru Bill Gross has said that we are witnessing the death of equities: "Stock investors should think again about the age-old "buy-and-hold" investing mantra. He says consistent, annual returns are a thing of the past."
It is difficult to see Taleb's comments as exposing anything particularly new. Of course, it is true that some investment managers do badly and not all investors are rational in the way they analyse performance. As a result, all investment managers have to compete with bad managers that hold a lot of assets. However, one respondent suggests that his conclusion – that therefore new entrants can't and shouldn't compete – is fundamentally ‘anti-capitalist'.
Steve wrote: "Nasim Taleb is right once every 10 years and since we are in year 5 since the last time he was right, he must be wrong. If as an investment manager or hedge fund manager you make money year in and year out you don't need to outperform the market. At some point if you are investing your own money and the pot gets bigger year, why do you need to chase performance or try to beat the market?
"What he is trying to say is actually very pernicious – only the big guys can succeed so please abandon the market. This is the most anti-capitalist statement he could possibly make. He almost sounds like a communist."
A better conclusion would be that investors need to know more about performance assessment. By definition in all industries, half of the staff underperform – ‘promoted to the level of their incompetence' is a cliché that will resonate with all who have been subject to their own equivalent of Dilbert's pointy-haired boss. The difference with the investment industry is that investors know about it. Investment managers can print flattering performance statistics, but any investor can head straight for Morningstar or Financial Express to uncover the real status of a fund manager's performance.
He is right that the industry is competitive. He advises: "Pick a less commoditized business or a niche where there is a small number of direct competitors." The real answer may be to compete and do it better.
Gross's argument is a little different. After all, he is an investment manager himself. He suggests that the historic outperformance of equities over bonds is an "historical freak" that isn't likely to be duplicated anytime soon, due to slowing economic growth around the globe. "The 6.6% real return belied a commonsensical flaw much like that of a chain letter or yes – a Ponzi scheme. If wealth or real GDP was only being created at an annual rate of 3.5% over the same period of time, then somehow stockholders must be skimming 3% off the top each and every year. If an economy's GDP could only provide 3.5% more goods and services per year, then how could one segment (stockholders) so consistently profit at the expense of the others (lenders, laborers and government)?"
However, neither Gross nor Taleb is arguing against competent active management. Gross is suggesting that equity market returns will not be as high as their long run average. The answer is not necessarily to buy fixed income, but to buy an active manager. Sue says on the Wall Street Journal site: "You cannot simply buy and hold "the market" as in buying index funds. If you do that, of course, in the long run you will not make much of a return if any. That is because, when you buy "the market," you buy the losers as well as the winners and it balances out. You have to identify the companies that will excel and buy them. That's not easy," you say. I agree. If it was easy to pick the winners, we would all be rich. But it can be done."
Equally, Taleb is saying that new entrants should not strive to be good active managers, because they will have to compete with too many incompetent managers. He does not argue that it isn't possible.
Ultimately, buy and hold may be dead (Gross) and there may be weak investment managers (Taleb), but the key is to encourage proper performance assessment to encourage investors to make better choices. The death of investment management has been much exaggerated.
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