(James Saft is a Reuters columnist. The opinions expressed are
By James Saft
April 17 Fund and pension investors who are
watching their biotech and social media stakes melt before their
eyes may well feel they've had their pockets picked by
self-serving investment managers.
But actually they are also helping to fund, if only as an
unintended side-effect, useful innovation which might not
The lesson here: career risk makes the world go round.
William Janeway, economist and venture capital veteran, put
it well at the Institute for New Economic Thinking conference
"The question is: how long can you afford to be wrong before
they take your money away and you are no longer in the market?
"It does not have to be a psychological propensity for
excessive risk taking, it is simply a matter of fact that in the
ontologically uncertain world in which market participants live
you cannot afford not to follow the crowd. Unless you are Warren
Buffett and nobody can take your money away."
When sectors of the economy surge, this puts pressure on
fund managers to get on the train, as funds flow towards and
away from those managers who show the strongest and weakest
performance. That encourages some to try to front run trends
even when they are not confident about valuations. Many more
fund managers are likely to feel forced to pile in, as we saw
last year, even when they may suspect it is going to be a
disaster in the end.
That's their fault for acting in bad faith and protecting
their career over your investment.
But it's your fault because you often fire money managers
who lag in a bull market.
Put it this way, while there are plenty of true believers
out there who actually believe that $17 billion or so is a
bargain for WhatsApp and Facebook, a whole bunch of other
money managers are simply scared into trend following.
Janeway argues that though they may do it cynically, it has
some good outcomes. He further believes that in general where
the technology has the potential to improve productivity, like
the Internet, or radio in the 1920s, and where the speculation
stays confined to the capital markets, the fallout when the
bubble bursts is usually manageable.
When it infects the banking system, as it did in the housing
bubble, the stakes and damage are much higher.
A good example of a beneficial bubble is sometimes said to
be the capital that flooded into electricity companies in the
1920s. That ended badly for investors but laid the foundations
for a surge in productivity during the 1930s despite the
Pity about the depression and losing your money, but at
least the lights turned on, eh?
There may be parallels today, Janeway points out. Amazon
had some crazy money thrown at it, and might not have
survived and be delivering us all olive oil by drone in years to
come if not for the cynical money managers.
None of this argues for investors passively allowing their
money managers to go trend-following. You will still get the
Internet and electricity even if you keep your money in an index
Another interesting comparison here is company managers, who
seem curiously unwilling to invest in new production despite
historically high company margins. While social media companies
throw money at seemingly every new idea, much of the rest of
corporate America is piling up cash and buying back shares
rather than tooling up and hiring people.
That too is because of perverse incentives which drive the
behavior of agents, in this instance company managers. The way
to get paid as a company manager at a reasonably mature company
is not by going all in for growth and innovation, but by making
your profit targets reliably in order to hit your share option
targets over the next one to three years. That argues for
cutting costs and playing safe rather than investing for the
That's also why we end up with multiple copycat drugs for
heartburn and why movies like Robocop get made over and over
again - they are safe bets.
Again, this is not generally in the interests of
shareholders, who are usually saving for the long term and who
may well see the value of their holdings wither due to low
levels of investment in research and development.
Don't get me wrong, I'm grateful for electricity, and
Twitter and even Robocop, but it strikes me that
somehow we ought to be able to organize this all a bit better.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at email@example.com and find more columns at blogs.reuters.com/james-saft)
(Editing by James Dalgleish)