All industries in my mind have some inherent weakness. With enough information the purchasers of any good and/or service can maximize their utility while minimizing their cost. This would have the effect of making money in that industry harder. As a result most industries try to obfuscate this information to make this difficult.
Take mattresses. Mattress companies make it hard for consumers to price compare by rebranding the same mattress when it is sold at different stores. Macy's, Saks, Sleepy's, etc may all carry the same bed but it will be branded differently so you can't make a true price comparison to find the lowest price. Carpet companies sell another product that works this way.
There is one significant weakness in the industry I work in, asset management.
It is impossible to differentiate one asset manager from another. I believe consumers of asset managers believe they are differentiated and I believe that asset managers themselves believe they are differentiated. But they are not. What do I mean by this?
With a differentiated product you would pick the best product that meets your needs at a price that seems reasonably to you. With asset managers that product is a mutual fund or a hedge fund or some kind of managed account. So how do we differentiate between these products?
The obvious point of differentiation is how good a fund or investment vehicle is at generating returns for you. How do we do that? The primary way is to look at historic performance. So let's do this with one of the better known funds out there - Legg Mason Value Trust (LMVTX).
This fund is run by Bill Miller. Bill Miller is best known for outperforming the stock market for 15 years IN A ROW. This guy is good. Clearly one of the best. From December 1995 to December 2006 he outperformed the S&P 500 by 169% (not annualized). Those are huge numbers. So you decide Bill's product is differentiated. And we'll even assume that somehow you had the magic ability to go back to 12/95 and stick your money in then.
How do you fare 2 years later? Badly. Your total return over the S&P 500 for those 13 years is negative 1%. Even though I spotted you 169% outperformance, you lost it all and then some in two years. Bill Miller is a below average investor.
So I ask you, if 13 years of magnificent outperformance cannot identify a good asset manager how can you possibly find a good asset manager? The answer is you cannot. It is impossible. Even if asset managers can consistently outperform the market, YOU HAVE NO WAY OF IDENTIFYING THEM. Period. And do I even need to mention Madoff at this point? Another outperformer who by most accounts just outperformed the market by minus 100%.
The crazy thing about this is that people in this industry and most consumers of these products can utterly convince themselves that they are outperformers if they have beaten the market even though you cannot separate what part of the outperformance was due to luck and what part is due to talent. This year I had a great year. But how can I really know that I wasn't lucky as opposed to really smart? I can't. On an honest basis you cannot answer that question. It is unknowable.
If all funds are created equal or at least you can't pick out a fund that is better than another (effectively the same thing) then it is a commodity and you should buy the cheapest one. In that case it is an index fund or ETF. End of story. This is exactly what I would do if I didn't get free financial services provided to me.
The only value an asset manager can bring to the party is to help you with other financial needs like automatically doing asset allocation or helping with estate planning. But then I would recommend just purchasing those services rather than paying a percent of the assets held with that financial planner.
Hopefully no everyone will read this so I will have a job next year.
My other view on why you should invest in funds which aim to match the market returns is that the market returns are really friggin good! Sure returns right now are bad, but unless you completely discount the exponential growth of the stock market over the last 100 years as an anomoly then expected future market returns are 10% or so. For doing nothing. Well not nothing. You're taking risk and dealing with market volatility. But you don't have to get your ass up off the couch to make this work. I say take the 10% and be happy. Why screw around trying to get 13% returns from a good manager who is going to take 2% of those returns back through fees anyway?
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