Only four days remain for money managers to beat their benchmarks or come up with rationales for their shortcomings. However, money managers won’t have much time for celebration or self-criticism, because the game will begin anew Friday. In other words, the 2014 money management race has been won or lost (mostly lost), but a new race to beat the market in 2015 begins immediately.
On the last weekend of 2014, I thought I’d spend some time trying to explain why this incessant race is inherently corrupting. Understanding the inherent nature of the money management is vital to arming you with the appropriate skepticism as you evaluate you manager and portfolio.
I hate to end the year on a somber note, but money management represents a growing and troubling aspect of our economy. Anyone with more than a bit of savings relies on money managers to some extent. They are the stewards of our retirement accounts, college savings plans and other long-term assets. Money managers allocate capital to companies of all sizes and across the globe. In other words, money managers are important intermediaries.
On one side, we have the collective savings of pensions, endowments and other forms of accumulated wealth trying to earn a return.
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On the other side, we have businesses attempting to attract investment and raise debt and/or equity to fund their companies.
Money managers sit smack in the middle.
Why is the practice of money management so corrupting and toxic to the preservation of values? In my view, money management has four essential characteristics, and they represent an unfortunate combination. I’ll begin with the unending nature of money management, move on to its lack of any tangible or even intangible product other than money, and then discuss its necessarily amoral framework, before concluding with a message that has been a consistent part of these columns.
As I mentioned at the outset, there’s no endpoint in money management. The game goes on and on, quarter-by-quarter, year-by-year until a money manager is fired or you ask for your money back. Every once in a while, a money manager admits that he can’t find appropriate investments and sends the capital back to his clients. However, most money managers will hang on to your money for as long as possible.
Think about the products and services created in any other industry. There’s a beginning and an end. Parts are shipped into a plant, and a car rolls off an assembly line. You provide your accountant with a shoebox full of statements and receipts, and she sends you a completed tax return. In money management, the product is never finished. Each day the interaction of the financial markets and the money manager’s trading reshapes the portfolio and changes the investment returns. At the end of a quarter or a year, there’s a momentary pause as the results are tabulated for clients, and then the chase begins all over again the next day.
Not only is the game never-ending, it doesn’t produce anything other than money (from an investor’s perspective, hopefully more of it). There’s no tangible product or service, just a statement with a bunch of subtotals, balances and percentages. Pull out your latest 401(K) statement and look it over. It shows a beginning balance, some contributions, gains or losses, and an ending balance (the fees are well-hidden).
What about the long list of portfolio holdings contained in the annual report or available for review online? Aren’t those something tangible? The average portfolio consists of 75 to 100 securities and turns over 75 percent to 100 percent per year. Thus, the stocks and bonds in an investment portfolio are just blinking symbols on a computer screen that a manager holds for a brief period of time (in some cases mere fractions of a second). A money manager doesn’t own stocks or bonds the way you own your home. Buying and selling securities is more akin to renting a hotel room for a night or two.
In the coming weeks, your money manager will probably send you a market commentary. Isn’t that commentary something tangible? Sad to say, most commentaries are mere entertainment and largely irrelevant to the task of managing money. The manager’s views on the current situation in Russia, the price of oil or the prospects for growth in China have little to do with the day-to-day task of managing your portfolio. Most investment commentaries (and I wrote many) are intellectual window dressing.
Thus far I’ve described a business that is ceaseless and produces nothing more than money. Those two factors alone create a difficult cultural environment. However, it’s the mental mindset of money management that is the most troubling.
Investing in financial markets is an amoral pursuit. It is not about right or wrong. Money management is a game of building collections of securities based on one’s predictions of corporate profits (stocks) or whether those profits will be sufficient to service interest and pay down debt (fixed income). It’s about deciding when to buy and sell those securities. It’s not about good or evil. Democrats, Republicans, liberals, conservatives, believers and atheists can be equally good or bad at the game, as their personal views are irrelevant when it comes time to invest.
A “successful” money manager checks his political or philosophical views at the door to his office and reclaims them on the way home. Those views have no place in money management. The money manager must try to see the value of an investment as it is, not in a moral or immoral context. Maintaining that mindset is no easy task.
Most money managers are smart, hardworking people. However, their efforts are delusional. Money managers believe that they can add value for clients, and yet the overwhelming evidence proves that they don’t. Thus, they spend their careers convincing their clients and themselves that they can beat the market, which is not a healthy underpinning for any industry.
The foundation of my former profession is fundamentally unsound because we play a dangerous game. True, there are armies of compliance professionals hovering around money managers, but their job is to monitor processes, not make value judgments. If compliance tries to inject value judgments into the investment process, they’ll soon be looking for another job or qualifying for the SEC’s whistleblower program.
Undoubtedly, some individuals and institutions in the money management business maintain a firm grip on their values. However, the industry only seems capable of appropriate standards of conduct when it is relatively easy to do so. The industry’s behavior in the run-up to the financial crisis, its conduct during the crisis and its quick return to business as usual is strong evidence that we ought to be very wary of the power and behavior of money managers in our economy and politics.
Most of my friends in money management will disagree with this assessment, and that’s understandable. They’ve devoted their careers to this business. However, when you step back to look at the business in a more nuanced light, you can clearly see that money management plays a troubling and yet vital role in our financial future.
Andrew Silton’s Meditations on Money columns can be found twice a month in The N&O’s Work&Money section. He is a retired money manager living in Chapel Hill. He was CIO for the North Carolina Retirement System from 2002-2005. He writes the blog http://meditationonmoneymanagement.blogspot.com/