Conspiracy Theory

Efficient Frontier's notoriety has brought me into increasing contact with members of the fourth estate, and I find myself occasionally sharing with these folks my Mittyesque fantasy of becoming a financial journalist. This usually gets a good chortle; "Hah, Bernstein, you sure screwed the pooch on that one. Don’t you realize that if you won’t write about active management you’ve lost 90% of your stories?"

Which gets me to the price-finding apocalypse. An entire generation of finance academics has learned that the fastest way to identify the pick of the litter is to explain the efficient market hypothesis to a Finance 101 class. At the end of the lecture, one hand usually goes up slowly, and a voice quavers, "But ma’am, if everybody invests passively, then who is left to analyze securities and determine their correct price?"

This is in fact just starting to be a real worry. Within a few years over half of the country’s biggest investment pool—pension money—will be indexed. And small investors will not be too far behind. The rear will be brought up by non-US investors. Who then finds prices for the market?

Now I know the answer. Like the poor, active managers and their shareholders will always be with us. It’s a stretch to call the relationship between money managers and the financial press a "conspiracy," but it is clear that each party desperately needs the other. Without active managers there are no stories, and without glowing manager interviews there are no pigeons. (Or, in Keynes’ aviary, "gulls.") The symbiosis between money managers and the press is hardly unique—one only has to think about fashion, automobiles, and travel, to name but a few. But it is hard to come up with one with such a large economic impact. Very few automobile purchasers are silly enough to buy on the basis of a favorable review in Car and Driver, but a glowing manager story can move vast amounts of capital.

So our capital markets will be safe as long as financial journalists need to eat. The irony is that if the day ever arrives that almost everybody indexes the few active managers left will indeed produce excess returns. Fortunately for the rest of us, this eventuality will be prevented by the large residua of press-related actively managed money.

copyright (c) 1999, William J. Bernstein