We’re swimming in it. Or maybe downing is a better term. Whatever the correct label, the digital supply of financial and economic data, information and analysis is exploding. We can’t get enough of it. Or are we getting too much? More to the point, Is it helping?
The question for strategic-minded investors is whether the growing amount of information is enhancing our investment results? This is a critical question, in part because the information revolution has only just begun. As David Leinweber notes in his fascinating new book Nerds on Wall Street: Math, Machines and Wired Markets, “We are just beginning to see the decentralized use of information technology in this industry.”
The future, then, is sure to be one of even more financial and economic information. But is more really better when it comes to investing?
Back in the good old days, when your editor was a staff writer at Bloomberg, there was a brief, shining moment when I thought the financial world was my oyster. In the early days of the job, I was awed by the apparent possibilities that arose from sitting in front of a Bloomberg terminal, which was made available to all employees. The array of data, news and analysis at my fingertips was overwhelming, but I was determined to become proficient at leveraging this amazing machine for not only my day job but for my personal investments as well.
As it turned out, access to a Bloomberg terminal isn’t a short cut to big profits. Don’t misunderstand: It’s a great resource, but simply having one doesn’t necessarily make you a better investor, although not having one may put you at a disadvantage. But whether it’s a Bloomberg terminal or the Internet, technology by itself doesn’t automatically elevate returns. One reason is that hundreds of thousands of other people on the planet have access to the same information. Fighting a war with nuclear weapons, so to speak, is a clear advantage if your enemy is using bow and arrow. But if everyone has a large supply of ICBMs, the game is something of a standoff.
Some of the challenge is no doubt tied to my own limitations. Surely there are countless investors who are smarter, and so they’re better prepared to make use of the digital revolution. But that’s not an entirely satisfying answer. As one example, consider the long-run history of the equity mutual fund business. Looking at the grand sweep of performance for this lot offers precious little evidence that results are improving. If anything, they seem to be getting marginally worse.
How could that be? Today’s mutual fund manager is armed with an array of technology that was beyond the pale in 1965, or even 1985, for that matter. In almost every other industry, technology inputs have enhanced results. Leinweber’s book has a wonderful chart showing how energy use in refrigerators has dropped dramatically over the past generation, as have prices of what one might call a digitally controlled ice box. At the same time, the size of refrigerators has continued to climb. In short, today’s ice boxes are bigger, more efficient and cost less.
Similar stories abound in everything from cars to medicine to aerospace engineering. Technology induced progress, it seems, is conspicuous in all corners of the modern world, with at least one glaring exception: finance.
Progress isn’t obvious on Wall Street. By the standard of the one metric that everyone cares about—returns—it’s not clear that investors are, on average, better off than their predecessors of earlier generations. And that was true even before the crash of 2008, or even the 2000-2002 bear market.
It’s debatable if progress per se is even possible in money management. Oh, sure, there are investors who reap greater rewards on a level that’s head and shoulders above what everyone else earns. Think George Soros and Warren Buffett, to cite the classic examples. Many more lesser souls have excelled too. Of course, one is reluctant to chalk up bonafide success in portfolio management to technology alone. Like Mozart and Einstein, some investors are simply born with raw talent. Technology helps, of course, but it rarely turns mediocrity into excellence.
As for the rest of us, is there any hope of progress from technology and the explosion of information? Not directly, although the prospect of investing smarter and reaping the rewards is still available. It’s just not the prize that the man on the street expects.
Earning ever higher returns simply isn’t possible on a grand scale. Never was, never will be. Rather, the great progress in financial economics and portfolio management is closely entwined with risk management. In turn, the opportunity to earn superior risk-adjusted returns is alive and kicking, as we’ve discussed many times, including here and here.
To be sure, risk management takes in a lot of territory and so quick summaries of how to leverage the progress in this area are elusive. But the basic message needs no elaborate explanation: Stop chasing return and focus on managing risk, which is a more productive way to manage money and reach financial goals, particularly in the context of a multi-asset class framework.
Unfortunately, the explosion of information, aided and abetted by technology, suggests otherwise. Recognizing that this is a myth for long-run results is the first step toward winning the money game.