Podcasts are a miracle. The printing press for the spoken word. Invest Like the Best sits right at the top of the stack for my weekly diet. But it’s not a new episode that’s been sticking with me lately. Rather, a 2023 interview with Aswath Damodaran, the Dean of Valuation, keeps resurfacing as I peruse the evolving investment landscape and sharpen the best tools for our clients at Root.
You can find the episode and full transcript HERE, I highly recommend.
From 01:11:21:
Patrick:
“Why do you think that there are still so many huge pools of capital, we’ll call them LPs, writ-large, that pursue a mostly active investment mandate and strategy. [Why] don’t we have more of the guy from Nevada that just put it all in the S&P 500 or something?”
Aswath:
“Hope springs eternal in human beings. Who wants to be average? Everybody wants to be above average. I don’t think that search is ever going to go away. And in a sense, active investing takes advantage of the fact that you want to be better than average. So, I think as long as that is part of human beings, you’re going to see people trying. And they’ll be attracted by stories of winners. And that’s why in VC and PE, the stories that are promulgated have that selection bias of ‘look how much money you could have made if you had invested in Uber on the ground floor.’”
Hope and Exclusivity: A Match Made for TV
Let’s pretend, just for a moment, that we’re the producers of Squawk Box. Let’s say we’ve managed to book Warren Buffett for a 3-minute segment. What should we ask him? What’s going to grab viewers’ attention—and keep them coming back?
For simplicity, imagine we have only two options:
- Tell the story of a construction business Berkshire bought for $200M in 2019 and recently sold for $3B, a 15x return!
- Talk about the benefits of dollar-cost averaging into an S&P 500 ETF and holding it long-term.
The choice is obvious for the producer. Where else can you learn about 15x investment opportunities? Viewers crave stories about outliers. No one tunes in to feel average.
Welcome to Our Shrinking Office
Aswath continues with thoughts on the future of asset management:
“But here’s what I can say, the steady-state number of active investors is going to be far lower than the number we see out there. There are far too many active investors, and we’re going to see the numbers drop off. So, all those buildings that Fidelity and State Street and T. Rowe Price fill up are going to be only one quarter or so in steady state because so much of what’s done there is just creating noise, it’s not adding value.”
That noise is now bleeding into ETFs. And if you’ll allow me, I’d like to air a few grievances.
For decades, “ETF” was shorthand for “passive.” Low cost, tax efficient, rules-based—what’s not to like? But that shorthand is now a marketing tool, and active managers are well aware.
Legacy mutual fund complexes are losing assets. Investors are fleeing high-cost, tax-inefficient structures, so the complexes are scrambling to reinvent their offering:
- Launching active ETFs
- Converting mutual funds to ETFs
- Applying for exemptive relief to launch ETF share classes of mutual funds
- Acquiring alternative asset managers with “deep expertise and strong track records” (please read as “fat margins and performance worth chasing”) to launch new product
Fun…and Games…and Mirrors
In the past few years, the ETF market has been flooded with all types of fun and games. Unless you’re actually investing in these ETFs, then it’s definitely not fun and games. Just to highlight a few:
- Actively managed thematic ETFs, marketed as “tactical” or “innovative” or “AI focused”
- ProShares, UltraShares, YieldMax, HELO, HALO. Why does it feel like AAU basketball? Every team used to slap Elite, Select, and Premier at the end of their name to make the kids feel, well…elite, select, and premier. There was nothing elite, select, or premier about those teams—and the same can likely be said for these ETFs.
- Liquid alts that offer high-fee diversification in response to stock and bond correlation in 2022. Sadly, yes, many are still flying down the highway staring at the rearview mirror.
Every week, my inbox fills with exclusive invitations to put our clients’ hard-earned money into “alternative” ETFs and evergreen funds that promise access, upside, yield, and diversification. The common thread? High fees and a wonderful story. Many of these products may technically be ETFs, but don’t confuse form with function. A pig in an ETF wrapper is still a pig.
A Final Stand
Can I blame them? I really cannot. These asset managers are fighting tooth and nail to save their businesses. The rise of low-cost indexing hasn’t just threatened their products—it’s threatened their entire model. So they’re adapting, rebranding, repackaging. In some cases, they’re doing all three at once.
And to be fair, many of them employ some of the best storytellers I’ve ever met. Their vice presidents and investment strategists know exactly how to position a fund as the missing puzzle piece in your portfolio—how to stoke FOMO by combining the perfect chart and perfect narrative.
Many advisors will fall victim to their final stand. Not because they don’t care—but because the pitch is just that good. It’s dressed in the credibility of an ETF, backed by slick collateral, and presented as the future of investing.
But don’t be fooled: the name on the wrapper doesn’t change what’s inside.
CONSIDER
A sticky note with Process > Outcome stares at me each morning when I sit down at my desk. One reason many investors end up with lackluster investment experiences is because they get so maniacally focused on the outcome. And when it differs from what they hoped, they throw the process out with the bathwater.
Process > Outcome
“Do I want to go on this journey even if I never get to where I’m going?” – Mike Rockefeller
“To travel hopefully is a better thing than to arrive.” – Robert Louis Stevenson
“The person who loves walking, walks further than the person who loves the destination” – Sal Di Stefano
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Let’s get after it this week!
Brooks
Brooks Palmer, CFP® is Head of Investments at Root where he helps identify, evaluate, and implement investment solutions tailored to clients’ needs. In Full-Court Press, he breaks down what’s happening in the markets—cutting through the noise and jargon—while connecting it to Root’s core investment tenets so you can make the most of your money and your life!
Advisory services are offered through Root Financial Partners, LLC, an SEC registered investment adviser. This content is intended for informational and educational purposes only and should not be construed as personalized investment advice or a recommendation to buy or sell any security. Any forward-looking statements, including expectations about market returns, are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future performance. Past performance is not indicative of future results.
