There’s a provocative post by finance professor, Noah Smith on BloombergView today regarding the rise of the robo-trading money managers (Wealthfront, Betterment et al). Mr. Smith doesn’t take sides but points out the industry is clearly moving away from active money management and toward passive, algorithmic keepers of our investment and retirement dollars.
The great John C. Bogle must feel vindicated by this trend, though decades ago when he founded Vanguard, an inexpensive index fund, he could not have imagined the digital strategies that are now marching over failing hedge funds and weepy money managers.
The jig is up. We know the excessive, opaquely structured fees of mutual funds have sucked off the gains of investors to averages below the stated returns of the funds. Over time, actual returns for investors are dramatically reduced by these fees. Is it any wonder why so much money is spent on advertising investment funds? The competition for your fees is fierce and every one of them beats some arcane benchmark, at least according to the copy writers. The problem is, as Saint Jack Bogle has been saying for years, “You can’t beat the average when you own the average.”
The rise of companies such as Wealthfront and Betterment is driven by two factors: a mobile-friendly millennial generation that thrives on connected models, and a growing disdain for those highly paid asset managers who often do not make good on their promises, but have facile excuses for keeping you invested with them.
I agree with Mr. Bogle as well as the concept of automated (low cost) investing. The S&P will provide you wonderful returns over the long run. Picking individual stocks is not for the lazy or risk-averse, or those whose who are too busy running their perfect progeny from lacrosse practice to Mandarin classes to bother. If you’re not willing to toss an extra scoop of coffee in the basket and pore over a 120-page 10K you shouldn’t gamble on individual stocks. However, I see a different issue down the road which we can file under, unintended consequences.
“Professor Smith asks, “What will replace active management? What form will the new passive world take?”
I ask, what will people say after this paradigm shift, when those managers remaining after the ‘great fall from grace’ are outperforming the herd by even larger margins? The best of the best, including the likes of Blackstone, Ray Dalio, David Tepper, Cliff Asness and Bill Ackman (Mr. Asness having the distinction of being the only one who is actually funny) will continue to do well and will undoubtedly attract more investments from those who eschew robotic returns.
This tiny legion will grow even more elite, drawing in more money, hiring the brightest stars of beta and creating a situation where the rich get richer, yet again, while the robot minions languish with average returns. As a Libertarian I’m all for it, of course—the whole free market thing. But I can envision an Elizabeth Warren trying to outlaw these beta outlaws, because, ‘it’s not fair’. Progressive crowing may create a cyclical shift back to active management, which would be wrong-headed.
The problem will be trying to prove a negative, to show those invested with passive systems that they should stay there, not despite average returns but because of them. It will be hard to convince those eyeing up the big players that, irrespective of the outsized gains of the Hedge/Quant/Big-Beta cohort, they are better off than they would have been had they left their money in mutual funds or worse, tried to pick and time the market with their own limited information. Average returns may sound, sort of, average, but they are actually very good. What we will need is not a shift away from robotic trading but a change in what we call the returns, so folks just feel better about them. Perhaps something from a gladiator movie, such as, Magnificum Returnas, or something start-up-ish like, Robucks (too Searsy?).
Overheard at a micro-single-malt-scotch-and-sushi bar on the Upper West Side:
“How many Robucks did you earn this quarter?”
“My nine-year-old daughter can speak Mandarin while playing the violin and writing code with her feet.”
“Go screw yourself.”