Unfortunately, these four horsemen also happen to be profit centers for Wall Street, creating an ongoing dilemma in investment management as to what is best for the provider and what is best for you as the investor.
Think of Jack Bogle’s cherished traditional index fund. This investment avoids the four horsemen at every turn. It’s simple, diversified, unleveraged and very liquid. By contrast, the average hedge fund is complicated, concentrated, sometimes leveraged and generally illiquid. Those differences are evident in their pricing. Perceived sophistication in the hedge fund allows its purveyors to extract a higher price, while the simplicity of the index fund commodities the offering and yields a low price. That’s one reason why cost is such an effective first-stage screen in the investment-selection process: Not only do lower-cost investments use less money, they also leave the four horsemen on the sidelines, improving investors’ odds of success.
The four horsemen offer a handy rubric for assessing an investment’s potential to treat investors kindly. In this context, it was dismaying to read the agenda of a recent high-level gathering of asset managers. Among the subjects were alternative investments, the asset-gathering triumph of a concentrated active mutual fund, and the rise of a new breed of brokerage firm that turns stock trading into a game but continues the old brokerage trade of providing margin accounts. Each of these actions calls forth one or more of the horsemen.
He along with alternative investing was the focus. There is an allure to the theoretical advantages of alternatives. A fund that zigzags when the rest of a portfolio zigzags could cushion investors during rough patches. But the evidence that investors have gained from more than two decades of experimentation with alternatives in the retail mutual fund space is scant at best. Alternatives are sold not at highs where they might hedge against lows, but at lows where they may blunt gains in highs. The more popular an investment idea gets, the closer the idea knitted in the hearts of investors finds its end, as former Clipper (CFIMX) manager Jim Gipson pointed out. Indeed, this has been true in retail alternatives, too, where all four horsemen have at times killed results. Even professionally managed target-date funds have not shown how alternative investments can be used in a portfolio to generate real dollar aftercost benefits for investors.
That won’t touch Wall Street, tho, from my Swifter. The astonishment-inducing slide of the conference compared the market capitalisation of Blackstone (BX), the alternative investment manager, with BlackRock (BLK), which is the giant of more traditional, and especially indexed, funds. The big takeaway was that while Blackstone houses a lower amount of client assets, it enjoys more market capitalisation. The takeaway: The easier road to success isn’t the scale game of selling low-cost, unleveraged, broadly diversified investment products, but peddling pricier, more complex fare.
That’s not the only way the four horsemen ride in alternatives. Another discussion point at the conference was in regards to a very specific thematic investment fund. Personally, I respect managers who go all-in on their best ideas but we’ve seen the movie before and we understand by now that such funds seldom achieve good investor outcomes. Think of the Janus funds from the turn of the millennium that attracted massive inflows (with celebrity advertising). Or Ken Heebner’s very top-heavy CGM funds, which won him a cover-story salute from a glossy business magazine in June 2008 as America’s Hottest Investor, just before the financial crisis struck. And they blew up, signing client assets to the tune of a 48% loss in America’s hottest investor his CGM Focus (CGMFX) for the full calendar year 2008. The concentration leads to higher highs but also the more base instincts in investor behavior as many get tempted to buy high. Until Wall Street discovers a way to enable investors to better glom onto these funds, those funds will be better bets for their issuers than for their buyers.
Yet another hot topic was retail brokerage, where investors have been chasing meme stocks. I’m for access to markets, of course, but I shudder at the real-world implications of frequent trading in equities you’ve researched little or not at all. The implications alone for tax-filing are a headache-inducing complexity. A broader issue, one by no means limited to any single brokerage, is the wide use of leverage. If you believe a Yahoo Finance-Harris poll and I think the results are stretched 43% of retail investors leverage their investments via options or margin accounts. This will not end well. Public mutual funds have a dismal record employing leverage and they are the experts. Worse still, retail investors will probably do no better. The hysteria over the liquidity problem during the plot over GameStop (GME) when trading was briefly limited is clearly overblown; the horsemen of concentration, tax complexity, and leverage are no less menacing.
The four horsemen also figure prominently in this issue’s Spotlight topic, private equity. At play here are complexity, concentration, leverage and illiquidity. The promise of democratizing access to private markets holds theoretical appeal, but a tug of war over how much of those benefits will accrue to different types of investors after costs is still in progress. If special-purpose acquisition companies provide any presage, small investors’ prospects don’t look good. Private equity has what it takes to be something Wall Street would be eager to sell; it will require a great deal of skill to make it something that wise investors would want to buy.
