Too Much Information
A few years back I suffered from sleep apnoea. Well, I didn’t really suffer because, being asleep when it happened, I didn’t notice anything. But Mrs R suffered, which meant strictly speaking I suffered from Mrs R’s suffering. I won’t bore you with the details of the condition but essentially you stop breathing for quite a long while. In my case I always started again, rejoining the land of the living with an explosive intake of breath, but not before Mrs R had been able to mentally spend the proceeds of my life insurance policies. Appreciating the frustration of living with the nightly promise of great riches only to have them cruelly snatched away at the very moment they seemed certain, I agreed to ‘see someone about it’.
During the following months of monitoring I appeared to have cured myself to the extent that by the time my Saturday morning appointment with the consultant came around I hadn’t had an episode for weeks. I was first on the list and we ‘d both arrived early so agreed to make a start. Unable to place his accent, I asked him where he was from. ‘That’s an interesting question’ – which it wasn’t, but the answer was. His family was Jewish. His French mother had been caught in the notorious Vel' d'Hiv Roundup and had been one of the very few who had escaped the Velodrome, avoiding transportation to near-certain death in a concentration camp. She met her German husband shortly after the war and, finding post-war France an unhappy place for any German regardless of religion, moved to Italy where they set up the first of many businesses. My medic’s childhood was punctuated by a series of business failures. His parents would set up in a town and, when the creditors’ angry letters and knocks on the door built to a crescendo, do a moonlight flit to a new town and start again. The interesting thing was they only needed to move twenty or thirty miles to escape any knowledge of their previous failures. I’ve been thinking of this in the wake of the latest data scandal. It’s great to have so much information only a few clicks away, but have we lost sight of the costs? Our every move seems to be recorded and accessible to whoever can be bothered to spend ten minutes surfing the web. Where would we be without Google? If I have a question I can get the answer in a few milliseconds. In fact, I can get lots of answers – if I ask Google how long it takes Google to answer a question it comes back with 392,000,000 results in 0.53 seconds. It’s unlikely I’ll look beyond the first ten. So, the brilliant thing about Google is it tells me what I want to know; the problem is it doesn’t tell me what I don’t want to know. It stifles he opportunity for serendipitous discovery. If it was harder for me to find the answer I’d trip over other things, new things, things that interested me, things I didn’t know that I didn’t know.
From the Trump victory to Brexit, the furore around Cambridge Analytica and Facebook shows the impact the ability to harvest and manipulate huge amounts of data could be having on our democratic process. But the implications of ever more available information spread far wider. Theory tells us that perfect competition requires an infinite number of firms. The larger the number of firms in a market, the nearer perfect competition becomes, driving prices down until they reach equilibrium at the point when marginal cost equals marginal revenue – in other words, the cost of selling one more product (or servicing one more client) exactly matches the additional revenue received. Firms will keep selling until there is no marginal profit in the transaction. Services such as Amazon and eBay accelerate the move towards perfect competition – markets become more efficient and prices are driven down by the visibility they afford. This creates new challenges for business – more than ever before they must turn to qualitative aspects of their product or service if they are to remain profitable.
In a strange way, much of the investment industry still competes essentially on price – the implied pact is that if you invest with Acme Fund Managers they will make you more money. A feature of the industry since the financial crisis has been the explosion in the use of passive funds; funds that promise to charge you less with the guarantee that you’ll make a marginally below-average return. The money world is split into two opposing camps – those who believe markets are relatively efficient and therefore paying someone to spot ‘winners’ is a mug’s game (the Passive camp) and those who believe a ‘good’ fund manager can add value over their fee (the Active camp). Inconveniently for the Active camp, more often than not the data suggest ‘good’ fund managers struggle to beat their passive alternatives.
I worked briefly with a chap whose first job at Norwich Union, shortly before the outbreak of the Second World War, was to answer the telephone. In his telling, there was just one telephone in the fabled marble hall of Norwich Union’s head office. Thinking about this, I suspect there was some poetic licence -never let the truth get in the way of a good story… Whatever, one of his duties was to call the London Stock Exchange each afternoon and get the prices of the top ten shares held by the Norwich Union Life Fund. He would scribble these onto a piece of paper which would then be taken to the small team of fund managers. That was the extent of the ‘real-time’ information for what would have been one of the country’s large investment teams – compare that to the data available to the most lowly of investors today.
When we speak of efficient markets it’s generally taken to refer to informational efficiency – the degree to which all participants have access to the same information at the same time. I suspect the reason for the poor performance of Active managers since the financial crisis is not down to ultra-low interest rates or a temporary paradigm shift that will right itself once extraordinary central bank measures are reversed. The answer, I believe, is more prosaic – the expansion of passive funds has coincided with a step change in informational efficiency that makes beating the market more challenging. In the short term this seems like great news – investing is becoming increasingly less costly and fewer people are losing their shirt to fund manager hubris. However, a market cannot be just followers; it needs price-setters – people who will give their opinion of value. It is the combined opinion of these price-setters that gives the passive investors something to follow. The fewer the number of active participants, the less efficient the market becomes as a mechanism for establishing a fair price. For a brief moment as I was writing this I thought I’d stumbled on a paradox - as a market becomes more informationally efficient so it becomes less efficient as a pricing mechanism. I had but, as Radi and James pointed out, I was far from the first.
Back in the consulting room, we got to my diagnosis. I explained my theory; after forty years of playing lock forward my neck had developed to cope with the inevitable knocks; having played less regularly this season it had lost some of its bulk meaning I could breath normally again. He looked me up and down before solemnly writing on my notes ‘has been playing rugby less often and lost weight from his neck…but put it on elsewhere’