If Wall Street were a TV series, collectively it would be dubbed “The Marketeers”. Such a potshot appears less surprising when we consider the advertising industry was practically built on Manhattan’s Fifth Avenue, a short 7-mile trek from the financial engineering capital of the world (which is more like a 3-hour drive in New York traffic…sheesh). Whether it is clothing, shoes, accessories, or financial institutions being hawked by advertisers, the mechanics and psychology of branding is the same. And some brilliant tactician figured this out long ago.
Depending on the source referenced, the hedge and mutual fund industries manage roughly $25- $28 trillion dollars combined. The private wealth management industry has been pegged at north of $50 trillion. If it sounds like a lot of money, it’s because it is! To put these numbers in perspective, U.S. Gross Domestic Product (GDP)—nominal value of all goods and services produced—approached $21 trillion for calendar year 2020.
Now, any logical human would naturally conclude that a money-management company charged with investing such vast amounts of hard-earned dollars (from individuals and institutions) ought to be damn good when it comes to return-performance. After all, is this not the reason we elect to go with active money managers over passive, or index-tracking, managers? That is, we expect our active money managers to, at the very least, outperform their benchmark indexes (i.e., S&P 500 Index, Russell 2000 Index, etc.), giving us some degree of excess, or what I like to call “above-average”, return to compensate for their lofty fees and justify their very existence. Of course, in finance parlance we have given this excess return a highfalutin, esoteric name: Alpha.
About those benchmark indexes. Let’s look at the S&P 500. Since adopting 500 stocks in 1957, the S&P has produced an 8% annualized return. Over the same period the U.S. has weathered 9 recessions (in fact, the 1950’s saw multiple recessionary periods) and 5 wars, if we count the Bay of Pigs invasion. Such secular trends certainly make the case for long-term investing. We are reminded that, if we can muster a little discipline and ride the up-and-down nature of the waves, over time our investment portfolios will do quite well.
On the other hand, what about the long-term return-performance of active money managers? To suggest that it leaves much to be desired would be the understatement of the decade. According to S&P Dow Jones Indices’ year-end scorecard on active management, 2020 marked the 11th consecutive year in which a majority of actively managed U.S. large-cap funds failed to outperform the S&P 500. In addition, of the U.S. large-cap funds in business 20 years ago, a mere 6% are, both, still operating and have beaten the S&P 500 over the same period.
None of this is exactly news of the groundbreaking sort (sadly, I am no Walter Cronkite). Yet, unfortunately, this has not stopped investors from piling into actively managed funds. The Wall Street Journal reported that at the end of 2019, $4.6 trillion was indexed to the S&P 500 in passively managed funds, compared to $6.6 trillion benchmarked to the index in actively managed funds.
And what about SPACs, or “blank-check” companies? I would be remiss if I gave them a pass. Despite their dismal performance, SPACs continue to enjoy great popularity with investors, pulling in a record $200 billion since the start of 2020, including $120 billion so far in 2021, according to data provider Dealogic. The sponsors (typically, big-named financial institutions) of SPACs, however, usually do remarkably well…of course. Let’s take Riverstone Holdings, for example. Its latest SPAC raised north of $300 million, despite its three previous SPACs’ barely breaking even or, in one case, losing 90%. Incidentally, the three previous SPACs raised a combined $1 billion.
“In general, actively managed funds have failed to survive and beat their benchmarks, especially over longer time horizons.” (Ben Johnson, Morningstar Research Services)
Now, for the million-dollar question: Why do investors continue to pour ungodly amounts of money into propositions hawked by historically losing institutions? Branding. Wall Street is a branding machine, spending hundreds of millions every year on advertising and promotion, to get their brand out there, so to speak. And, obviously, it has observed some positive correlation between advertising dollars spent and the attraction of capital. It becomes a no-brainer that has turned our basic business proposition upside-down. Unfortunately, we are no longer in a performance-based business…but a brand-based business. To any active money manager worth his salt, this is a sad reality.
After ingesting all of this, we are left with a very unsavory interpretation: many investors— individuals and institutions alike—would much rather do business with a poorly performing brand they recognize, than a relative newbie with a benchmark-beating performance. Even more unfortunate is the fact that some of these individuals and institutions are responsible for allocating the capital of others, which suggests their blind preferences are impacting the financial goals of their clients or other contributors.
I recently sat down for a conversation with Cory Nettles, founder and managing director of Generation Growth Capital, a private equity firm in Milwaukee. Cory summed up the situation exceedingly accurately: “There are people who perform at an impressive level but do not market themselves well, so people don’t know they exist. Then, on the other hand, there are people who perform at an average level but are great marketers and, therefore, attract capital or interest.” I could not have said it any better myself.
It is my hope that, sooner than later, investors wake up to the unpleasant marketing aromas of Wall Street. There’s a reason the Bull of Wall Street, a bronze sculpture, sits on Broadway in Manhattan’s financial district…it is not the smell of coffee you’ll be waking up to, I assure you.