By Robert Seawright, Proprietor, Above the Market
I was a Duke student before Coach K came on board. Duke basketball was a big deal on campus then, but its aura was very different. We weren’t remotely a juggernaut or a national name. In fact, within just a 25-mile radius, we were well behind both UNC and NC State in terms of basketball history and regard. But we were very good fans, filling the seats and supporting our team. We were aggressive too. Our shtick was not just to be loud and intimidating but also to try to be funny and snide so as to unnerve our opponents. Sometimes we were even offensive. Imagine that.
We invented the “Airball!” chant in 1979 for an opponent’s shot that misses everything. Thank you, Rich Yonaker. After I graduated it was chanted in German at future NBA starDetlef Schrempf who was, of course, German. We greeted the visiting USC Trojans by throwing condoms on the court in 1978. We always urged NC State’s then coach to “Have a drink, Norm Sloan, have a drink” because he had commented in the press about the alleged insobriety of Duke students in the stands. We jangled car keys during his free throws in an otherwise silent Cameron Indoor Stadium at State guard Clyde Austin, later imprisoned for a Ponzi scheme, who was being investigated for having no job but two luxury cars, supposedly given to him by his bank teller girlfriend. Pizzas were delivered to a State huddle because a Wolfpack player was in trouble for hassling a pizza guy. When Maryland coach Lefty Dreisell (Duke, 1954) and his Terps visited, Lefty was greeted with a big sign and these words: “Richard Nixon [Duke Law, 1937]: Duke’s second biggest mistake. Welcome Lefty!”
A regular chant in our rotation was reserved for when a very highly regarded team or player visited Cameron and didn’t perform up to reputation. “OV-ER-RAT-ED!” Sadly, and by any reasonable measure, it is impossible to conclude that the financial services industry is anything other than wildly overrated. Chant away.
The financial services industry has grown and is growing as a share of the overall economy at an astounding rate.
Berkeley economist Brad DeLong has noted that our industry accounted for 2.8 percent of domestic GDP in 1950 compared to 8.4 percent of GDP in 2011. “[I]f the US were getting good value from the extra…$750 billion diverted annually from paying people who make directly useful goods and provide directly useful services, it would be obvious in the statistics.” In other words, the financial services industry should provide value in a demonstrable way, especially because wages and other forms of remuneration in the financial sector have grown so enormously since 1980. But there is precious little evidence that it has done so.
Good research suggests that our industry has become ever more sophisticated and complex over the past three decades or so but to little effect. In fact, fully 2 percent of GDP has been wasted in the pointless hypertrophy of the financial sector – we got paid more but didn’t produce more – evidence that America’s financial system is less a device for efficiently sharing risk and more a device for separating customers from their money. Moreover, there is no correlation between stock market valuation measures or GDP and Wall Street rewards.
In related news, financial development, while helpful to economies early, fairly quickly becomes a drag on overall growth as time passes because it competes with other sectorsfor scarce resources, including talented workers. In the words of Adair Turner: “There is no clear evidence that the growth in the scale and complexity of the financial system in the rich developed world over the last 20 to 30 years has driven increased growth or stability.”
In my view, this lack of economic productivity, while bad news for the economy and amajor cause of rising income inequality, might still be acceptable (or at least defensible) if there were evidence that the financial sector provided real help to investors generally and to individual investors in particular. Unfortunately, we have seen no such evidence.
Every year the Dalbar QAIB examines actual investor returns and every year the suffering of the individual investor is made plain. The latest data shows that for 2012, the average equity investor underperformed by 0.42 percent and the average fixed income investor underperformed by 0.47 percent. To those not comfortable with statistics, that may not seem substantial, but over the past 20 years, the average equity investor’s annualized returns have totaled 4.25 percent compared to annualized S&P 500 returns of 8.21 percent, aggregate underperformance of nearly 50 percent, and the average fixed income investor’s annualized returns have totaled 0.98 percent compared to annualized Barclays Aggregate Bond Index returns of 6.34 percent, aggregate underperformance of nearly 85 percent.
Similarly, the S&P Dow Jones Indices year-end 2012 report compared the performance of actively managed mutual funds against their benchmark indices. This annual SPIVA Scorecard once again shows that actively managed funds tend to underperform their benchmarks.
“The year 2012 marked the return of the double-digit gains across all the domestic and global equity benchmark indices. The gains passive indices made did not, however, translate into active management, as most active managers in all categories except large-cap growth and real estate funds underperformed their respective benchmarks in 2012. Performance lagged behind the benchmark indices for 63.25% of large-cap funds, 80.45% of mid-cap funds and 66.5% of small cap funds.”
This general inability of managers consistently to outperform their benchmarks is related to the results of the S&P persistence scorecard showing that high performing funds tend not to maintain their good performance for long. Of the over 700 funds that were in the top quartile of mutual fund performance as of September 2010, only 10 percent of them remained in the top quartile at the end of September 2012. In other words, only 2.5 percent of all actively managed mutual funds in the S&P sample were in the top quartile in both September 2010 and September 2012. Random chance alone would suggest that 25 percent of funds should stay in the top quartile for 3 straight years and 6.25 percent for 5 straight years. Thus actively managed funds, in general and in the aggregate, underperform their benchmarks and fail to maintain their outperformance when they actually achieve it — by a lot.
Hedge funds, the least regulated and most highly compensated area within the finance sector, if anything, have performed even worse. In his book, The Hedge Fund Mirage,Simon Lack, a hedge fund insider from his long tenure at JPMorgan Chase, showed that the hedge fund industry as a whole lost more money in 2008 than it had made in all of the previous 10 years. Even worse, “if all the money that’s ever been invested in hedge funds had been put in Treasury bills instead, the results would have been twice as good,” especially since nearly all the hedge funds’ gains went to managers rather than clients. Masters of the universe indeed?!
Such dreadful performance impacts real people in real-time, of course. Most prominently, we face a major retirement crisis. Debt, deficits and demographics are all working against a healthy retirement. So is a lack of saving. “We’re facing a crisis right now, and it’s going to get worse,” Alicia Munnell, director of the Center for Retirement Research at Boston College, recently told The New York Times. “Most people haven’t saved nearly enough, not even people who have put away $1 million.”
So $1 million isn’t nearly enough in today’s interest rate and equity market environment, but according to the most recent data, the average and median IRA account balances are $67,438 and $17,863, respectively, while the average and median IRA individual balances (all accounts from the same person combined) are $91,864 and $25,296. The average 401(k) balance is $80,900, $150,300 for those age 55 and up. Those current balances are a looooong ways from $1 million. We aren’t saving enough, surely, but dreadful investment performance has made a big problem much bigger. When we do save and invest, we get very little bang for our buck. All too often we get banged.
As an industry, we’re really good at making money for ourselves. For our clients? Not so much. Matt Taibbi’s memorable description of Goldman Sachs in 2009 aptly describes the financial services industry as a whole. It is “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”
Overrated doesn’t even begin to cover it.
Latest posts by Robert Seawright (see all)
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