Capco Blog

Investment management is a sound career choice

Nassim Taleb’s recent paper, “Why It is No Longer a Good Idea to Be in The Investment Industry,” has caused quite a furor due to his recommendation that people who are starting their careers should stay away from investment management because success is overwhelmingly determined by the luck of the draw.

This advice is nothing new; I heard something similar in business school more than 15 years ago. Only then, the reason was couched in market-efficiency terms, that is, an efficient (or mostly efficient) market means that the likely expected returns to investment acumen are slim. Taleb merely takes the flip side of this argument — that the returns for investment acumen are dwarfed by mere chance in commoditized (efficient) markets. He also posits that globalization has concentrated the returns in fewer and fewer players, which means the overwhelming majority of players in the industry will have been crippled by a history of market-trailing returns, and the lion’s share of investment funds and resulting management fees will go to the (merely) lucky few.

Of course, this is why many savvy investors have moved to index-based investing for large parts of their portfolio. There is no reason to reward investment managers whose market-beating returns are due purely to chance. Active management should be concentrated in those portfolios where markets are less efficient and where management skills, connections, access or other elements besides investment selection are likely to determine whether returns beat or trail the market.

This also provides good insight for investors who are looking for an investment manager. When choosing a manager, investors should consider the following:

  • Refrain from chasing returns, which is futile when past returns are not indicative of future performance, as in an efficient market.
  • Be skeptical of any claims of competitive advantage in investing in what should be a relatively efficient market.
  • Do not pay managers for their past luck. Expenses matter.
  • Closely examine the claimed drivers of investment success, even in inefficient markets. After all, just a few favorable transactions or returns juiced by high leverage or in an attractive sector can make a mediocre manager look like an investing star.

Do you think investment management is a wise career choice for those just entering the workforce?

Comments

Nice article. I feel that the best investment managers are those in their 40s -- they have amassed enough worldly knowledge, contacts, and income that they can make sound, thoughtful decisions, without shooting for the stars, taking on too much risk. And they still have another good 20+ years available to build up a responsible track record, so they will still care about their results.

I think that’s probably a good rule of thumb, but for a slightly different reason: Managers in their 40’s have typically been in the industry long enough to have seen the ups and downs of the market, and at least some of the effects of random chance / luck should have been offset from their track record. Of course, given survivorship bias, every investment manager in their 40’s was probably lucky early on, otherwise they wouldn’t have been able to survive in the industry. But we can probably assume they have also had the chance to hone their skills over time to become more expert at what they do.

But the original advice still holds: If there isn’t compelling evidence of inefficiencies in particular markets, investors are probably better off putting their money into index funds or other diversified, low-cost options rather than hoping a portfolio manager can duplicate past performance.

As a current student that is studying finance this article made me stop and think. Yes, we all know that trying to beat the index can be a formidable task, but there is always room for mangers that use a hybrid passive/active model. In my investment experiences I have never used mutual funds and have switched to about 80% ETF products and 20% equities. Thank you for the article!

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