Business Outlook: In Defense of (Some) Experts

TOO MUCH OF A GOOD THING: Former Cabinet Minister, Michael Gove, recently famously said that his nation had had “enough of experts” in the run up to the Brexit vote. /REUTERS

BY John D’Agostino 

It’s a bad time to know what you are talking about.

‘Experts’ are out of favor. Driven underground, pods of highly trained individuals are left to scavenge for anyone who will heed their clarion calls on Brexit, asset bubbles, vaccines, climate change, immigration, race relations—you know, the simple stuff. Doctoral candidates stand helpless as their Twitter followers plummet from low double digits to high single digits.

Things are so bad for experts that they leapfrogged neutrality and shifted directly from ‘respected’ to ‘whipping post.’ Politicians have amassed massive public support by pitting themselves against the expert consensus—tapping into populist frustration and resentment years in the making. Specifically, eight years in the making, since the economic elite largely missed the 2008 financial crisis (and some would argue, in fact caused it).

As such, this resentment is particularly acute in the world of finance, and more specifically, alternative investments, and there is a simple reason why. It is well deserved—in a sense.

First, a definition. Alternative investments (private equity funds, hedge funds, etc.) are simply investments that seek to produce returns uncorrelated to more traditional investments such as the stock market and the bond market. Private equity, or investing in private companies, and hedge (investing in public or listed securities) are just legal vehicles by which to do that. The strategies they employ can get quite complex—but the basic idea is not. You give them money, they invest it in a manner that hopefully does not track (and hopefully exceeds) something you could do yourself, and they give you back your profit (minus a fee). That’s it. They seek to generate a greater return than you can make, or a return that is more stable or otherwise unrelated to whatever you could practically invest in.

Producing a return that is greater than the market is particularly useful, as it’s starting to seem that long term returns generated for decades by global markets pre-2008 may not be the same going forward for several generations.

This hurts everyone; especially pension funds, which, like banks, don’t have all the money they technically owe to future pensioners. They rely on a return to generate the money they need to pay out to pension holders over time. Without alternative investments, it’s unlikely they will achieve this return.

So, if alternative investments help pension funds get the money they need to give pensioners a stable retirement, why are they maligned in the press on a daily basis?

For the same reason, economist arguments were counter-productive in the Brexit narrative and politicians’ immigration views have lost all credibility in the face of massive human suffering. Because, in aggregate, they deserve it. In aggregate, they have been wrong more often than they have been right. The key term, however, is “in aggregate.”

Expertise, or at least the pretense of, has never been easier to achieve. The optics of excellence—from a shiny website to infinitely scalable digital distribution of content and personal brands—are virtually free.

Whereas it used to be a unique honor afforded to the accomplished to speak on financial news shows, talking heads now fill the screen like the opening credits to the Brady Bunch.

For alternative asset managers, aggregation takes the form of various indices that cull proprietary databases of fund performance and present an average meant to represent the industry as Dow Jones Industrial Average represents the overall stock market. The problem is that stock market indices, in theory, represent a basket of stocks that the average retail investor would own in a broad based mutual fund. So the performance of the index should, directionally, match the performance of the investors’ holdings.

Indices of hedge and private equity funds serve no such purpose. They conflate skill levels to a point of meaninglessness. It’s as if you averaged out all the 100 yard dash times in the Olympics, collegiate and high school athletics and compared that result to expectations of excellence.

Expertise has become easy to fake, and inclusion into elite groups simple to achieve. The fetishizing of data leads to a belief that more data elements are always better than less. But when the goal is complex like forecasting (weather or stock prices) crowd-sourcing fails miserably and actually magnifies errors. The more difficult the task, the harder it is to be exceptional, and so it’s no surprise that the performance of the top alternative investment managers is significantly better than the mean return of the entire group.

We see the same mistake in grouping large numbers of scientists in order to shed false doubt on expert consensus—be it evolution or vaccine use.

The tyranny of the mean. Globally, retirements are in peril. Pension schemes around the world face obligations they cannot meet through passive investment. Without true, rare expertise, funding gaps will not close, and countries will be forced to decide whether pensioners lose out, money will be created to fill the gap (inflationary pressure) or taxes will be increased on the current generation to pay it forward.

There is no greater and nobler use of the torch and pitchfork than to unseat a false expert. But instead of pillorying the elite due to the obfuscation caused by the inclusion of the many, calmer heads need to prevail and assets allocated to the small universe of people and companies that have the scale and ability to manage it for the benefit of us all.

John D’Agostino works in finance but is absolutely not an expert so please put your pitchforks away. He was the subject of the NY Times bestselling book Rigged about the building of the first derivatives exchange in the Middle East—but that fact should not impress you.

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