There is a myth that is consistently floating around that I would like to dispel. The myth is that certain organizations reap vast rewards because they have hired the “best and the brightest” or the crème de la crème. I am entirely tired of hearing that. This phrase often is associated with those in finance with it being besowed upon the old Salomon Brothers, Enron, LTCM, Madoff, AIG Financial Products, and now Goldman Sachs. In each one of these cases we are driven home the point that corruption or exposure to fat tails was the key to success, not their superior ability within the financial markets. The fact is, no firm or person has supreme ability in the financial markets and if something appears too good to be true than it is.
Money managers and traders fall into three natural camps: Good, OK, and Bad. That’s it. You might come across teams of analysts and portfolio managers that can consistently beat the market. Some of those teams are truly better than average, but at the same time they do not exhibit stellar performance in which they outperform their benchmark by 10%+ per year. Some of those “good” teams are actually just lucky. Yes, it is statistically probably that with thousands of investment teams out there a few will just be on a lucky streak and look like rockstars.
The rest of the managers, investors and traders are just muddling along and introducing transaction costs and fees that erode long-term performance. John Bogle has been shouting from his soapbox for years that this very fact is the reason that most should invest in cheap index funds. I find it hard to disagree from a broad perspective. Unless you have the time and resources, *most* individuals and small institutions would be better indexing a lot of their investments than chasing expensive mediocre managers.
But let us get back to the point of this post: the “elite” among us. This is such a horrid lie. The smartest individuals that I have ever known are mostly quantitative analysts, engineers, and computer scientists. The individuals in these groups might not be the most socially graceful, but many exhibit superior logic, intuition, creativity, and problem-solving skills. Is Goldman Sachs filled with engineers and scientists? Most definitely not. Goldman Sachs is filled with a bunch of money hungry and often unethical groups of young men and women who are willing to package and sell anything to anyone as long as it creates a fat commission. If you want to get an inside look at the culture of the derivatives business within investment banks, please read the highly entertaining book Traders, Guns & Money by Satyajit Das. If you want to get an inside look at the investment banking culture of IPO’s, mergers, etc, please read the other highly entertaining book Monkey Business: Swinging through the Wall Street Jungle by John Rolfe and Peter Troob.
So the next time someone tries to convince you that a firm or group is making a lot of money because they are better or smarter than everyone else, just tuck that away in the back of your head and either wait for the blowup (AIG, LTCM) or the fraud (Enron, Madoff).