SOMETHING FOR THE WEEKEND
Alpha.
Fittingly for an industry that likes to make everything far more complicated than it needs to be, investment professionals tend to refer to two of the most basic capital market concepts by the first two letters of the Ancient Greek alphabet.
For the uninitiated, alpha is a measure of an investment’s performance compared to a benchmark — the FTSE 250, say, or the S&P 500.Beta, on the other hand, is a measure of the volatility of a particular security in comparison to the market as a whole — in other words, the tendency of its returns to respond to swings in the market.
Many of those who work in the investing industry are driven by the pursuit of alpha, or trying to beat the market. The media is also obsessed with the need to “outperform”, hence the plethora of articles about “undervalued” sectors or individual stocks that are due for a rebound.
As every evidence-based investor knows, alpha is extremely hard to find. Those who claim to know where to look for it exact a high price for their “expertise”, and yet, for whatever reason, the vast majority of professional money managers will fail to find it and take your money anyway.
What does the future hold for investment consultants?
The investing industry is littered with broken business models, but there’s none more thoroughly smashed to pieces than investment consultancy.
Research consistently shows that consultants extract value from the investment process; a US study in 2008, for example, found that the money managers who are fired by fund trustees on the advice of consultants subsequently outperform the managers who are hired.
Now Warren Buffett has put the boot in. At last weekend’s annual meeting of Berkshire Hathaway shareholders he explained in no uncertain terms how consultants generally make the recommendations they do out of self-interest; how they typically refer trustees to other consultants who in turn charge high fees; and how they continually tweak the advice they give so they can keep on charging year after year.
“No consultant in the world,” said Buffett, “is going to tell you, ‘Just buy an S&P index fund and sit for the next 50 years’. You don’t get to be a consultant that way. And you certainly don’t get an annual fee that way.”
Is the UK media really not interested in fee transparency?
Every day, newsdesks have to make quick decisions on dozens of stories, and whether they’re worth covering. It’s what we journalists call “copy tasting”. Which stories get reported on depends on a number of factors — for example, how busy a news day it is — and often it comes down to the personal choice of the news editor on duty. Inevitably, there are some very big stories that go uncovered.
An example came last week when David Cameron was quizzed at Prime Minister’s Question Time about the lack of transparency surrounding fund management fees by a Conservative MP who recently discovered that he was paying three times as much in charges on his investment portfolio than he had been led to believe.
The Prime Minister replied by saying that lack of understanding of the true costs of investing is “sapping people’s enthusiasm” for saving for retirement.
Of course, I’m not a dispassionate observer. I’ve said for years that fees and charges are far too high, that they aren’t properly advertised, and that most people (including many investment professionals) have little clue about the impact that compounded costs have on long-term returns. But I do find it extraordinary that this story went almost totally unreported.
The Gospel according to Buffett
There are few keener advocates of index funds than Warren Buffett. Over many years, Buffett has consistently stated that indexing is the logical solution for the vast majority of investors. He did it again at the Berkshire Hathaway shareholders’ meeting at the weekend — only this time he spoke on the subject at greater length and in even more emphatic language than he has in the past.
Just before lunch at Saturday’s meeting in Omaha, Buffett spent twelve-and-a-half minutes delivering what he jokingly referred to as a “sermon”. In it he spelled out his opinions on the merits of index funds compared to actively managed funds. I would strongly urge investors to watch the relevant section in full — it begins at around 2.42.20 — but here is a summary of what he said.
Other TEBI posts you may have missed
First it was Obama. Now Cameron speaks out on fund fees
The voice with nothing to sell is hard to hear
The less you pay the more you end up with
Also worth reading
Buffett:
Why Warren Buffett is right to warn about the loser’s game (FT)
So, Buffett’s convinced you that indexing is best. How do you go about it? (Eric Balchunas)
The world’s best stockpicker proves the case for passive investing (MoneyWeek)
Money manager musical chairs is costing pension funds a fortune (Ben Carlson)
Fund performance:
New research underlines how important it is to keep your costs down (Russel Kinnel)
How do Fortune’s “Most Admired Companies” perform compared to index funds? Not well (IFA.com)
Other research:
Study shows that those who retire later live longer (Ann Lukits)
We can all be manipulated by financial ads, but older investors are more susceptible (Josh Brown)
Behaviour:
How do testosterone and stress affect financial decision-making? (Wesley Gray)
Personal finance:
7 lessons I would give to my 20-year-old self (Jeff Rose)
Why being focused on any single asset class is a mistake (Charlie Bilello)
A third of newlyweds are surprised by their spouse’s financial situation (Polly Mosendz)
You might not be as wealthy as Prince was, but you need a will (Barry Ritholtz)
The bigger picture:
A lot of the “good old days” we look back on never actually happened (Morgan Housel)
Index investing makes markets — and economies — more, not less, efficient (Wayne Duggan)
Have a great weekend!
Robin is a journalist and campaigner for positive change in global investing. He runs Regis Media, a niche provider of content marketing for financial advice firms with an evidence-based investment philosophy. He also works as a consultant to other disruptive firms in the investing sector.
