Selling shit, as long as shit can be sold
The last couple of weeks was like a festival for all value investors, Warren Buffett and Charlie Munger fans. First, Charlie Munger, who’s now 97 years old, spoke for 2 hours at the Daily Journal Annual Meeting; he’s bloody superhuman. And next, Warren Buffett’s Berkshire Hathaway annual shareholders letter came out.
Before I go further, I have a confession. I’m not as ardent a fanboy of these two people as most people are. I haven’t read much Buffett and Munger content as most other investors would have either. It’s somewhat become fashionable to take potshots at Buffett given that Berkshire Hathaway has underperformed the S&P 500 for about a decade now.
But I think these two are among the greatest active investors of all time. But on a side note, I think the reason these two evoke strong reactions is that a lot of investors somehow think blindly aping and applying what Buffett says or does is a sure shot way to investing success. What these people don’t realize is India isn’t Amrika, and context is king. The game that Warren Buffett plays is way different than a lay investor screening value stocks on Moneycontrol. And those quotes, my god, It seems like they’re used to justify just about every stupid thing in investing.
But having said that, despite these two being extremely active investors, they’re huge fans of the humble index fund, and this puts my confirmation bias on steroids.
RobotMaths @robotmaths@jonronson Do your confirmation bias one again.
I was listening to Charlie and reading Buffett’s letter, and there were some commonsensical pieces of advice that we all know but need to hear again for the 3873rd time.
Here’s what Charlie Munger had to say when asked about SPACs. A SPAC, if you’ve never heard of it before, is also known as a “blank check company”. It’s a shell company listed on the stock exchanges with the explicit goal of acquiring other companies. This allows the company that is getting acquired to bypass the long-drawn-out and costly IPO process. SPACs have become all the rage, and US SPACS raised $75 billion in 2020 and they’ve already raised over $60 billion this year. The last time they were this popular was in 2008, and we all know how that movie ended.
Here’s what Charlie had to say about SPACs or as I like to call them selling packaged crap:
Question: It seems like everyone—including actors, athletes, singers, and politicians—is getting into the business of promoting their own SPAC. What do you think of all of the SPACs and the promoters pushing them?
Charlie Munger: Well, I don’t participate at all. And I think the world would be better off without them. I think this kind of crazy speculation in enterprises not even found or picked out yet is a sign of an irritating bubble. It’s just that the investment banking profession will sell shit as long as shit can
As I was listening, the last bit struck me. It doesn’t just apply to the investment banking profession but also the financial services as a whole and the investment management profession specifically.
A vast chunk of what passes for investment management today is just selling shit to extract as much money from investors as possible. I’ve written earlier, and I’ll say this again. The investment management industry, with a few exceptions, are rent-seekers incentivized to gather assets but not deliver performance.
If you’re new to this whole investing thing, the way an AMC gets paid is it charges a fee as % of the total assets. So if a fund has Rs 1000 crores AUM and if the expense ratio is 1.5%, the AMC makes Rs 15 crores. It doesn’t matter if it beats the benchmark or doesn’t. It’s going to keep making money, come rain or shine.
In an ideal world, the fee should’ve been linked to performance. A fee structure where the AMC makes the full 1.5% if it beats the benchmark or charges a lesser fee if it doesn’t. Or at the very least, charge a lesser and reasonable fee. But unfortunately, this isn’t the case due to a whole lot of reasons. The AMCs have no incentive to charge this way because, well, they are profit-seeking entities, and their job is to make as much money for their shareholders as possible.
This applies to AMCs as well👇
The investors are, for the most part, unaware, lazy, and ignorant, which means they don’t ask the AMCs to charge this way. So the AMCs continue to milk the investors for all they can without having to bother about delivering performance. As an aside, all fee models have trade-offs, but a fee model where the AMCs make money no matter what the performance is the absolute worst, and it’s downright unethical in my view.
Due to this perverse incentive, all these AMCs are in a rat race to build AUM and extract profits without having to bother about performance. AMCs milk inertia in investors to the maximum extent. Humans hate change, and nowhere is this more costly than investing.
If you think I’m overly dramatic here, go take a look at the top 10 AMCs and how their funds have performed vs a simple benchmark like the Nifty 50 over any period of time.
Quoting from a previous post I had written:
The total AUM of actively managed Indian large-funds is Rs 1.7 lakh crores. And hardly 5-10 funds of the 32 large-cap funds beat Nifty 50. Indian investors are paying between Rs 2000- 2500 crores in commissions every year for not beating the benchmarks, whattay fantastic deal! Add to this the fact that most multi-cap funds (now flexi-cap funds) are essentially closet large-cap funds. That’s nearly 3 lakh cores of AUM that underperforms a Nifty 50 index fund that charges just 0.1%.
Indian investors are paying nearly Rs 4000-5000 crores in commissions to “star fund managers” who can’t even keep up with Nifty 50, let alone beat it. In some cases, they can’t even keep up with a fixed deposit. 🤦♀️It’s daylight robbery masquerading as asset management.
It’s not the fees. It’s the way they design and launch products. In the past couple of years, international funds have become all the rage among investors because US markets have delivered eye-popping returns. And if a theme is hot, there’s money to be made here. All major AMCs have launched or filed to launch several international funds, and these are mostly fund of funds (FOFs) that package existing schemes in the US or Europe. Even a cursory look at the performance of the underlying funds in these fund of funds (FOFs) shows that they are largely useless costly funds, but investors don’t care. And this shit is being sold like there’s no tomorrow.
Look, start with a default assumption that I am a Cassandra, a hypocrite, and a person who makes things up. You can find all the filings of these funds here. Check them out yourself. You don’t have to take my word.
Investors, despite knowing they hold shitty funds prefer to keep putting money in them than get rid of them because of inertia. And this inertia is the greatest moat of the investment management industry. As long as humans hate making changes or take action, the AMCs will continue to squeeze investors for all they can.
They can focus on asset gathering, selling shit and not delivering performance comfortable in the knowledge that a vast majority of the investors don’t care about the garbage they are sold.
Never bet against inertia.
And the worst part, the people in the asset management industry know and admit they are selling terrible products for the sake of asset gathering. I was speaking to someone from an AMC that was launching a new fund. The strategy of the fund had no basis or academic evidence backing it up. But this person justified the launch by saying that they had spent a ton of money on research, data etc. I swear, I’m actually underselling this conversation.
And while engaging in all these shenanigans, the AMCs in a slap to the face of English, logic and reason, nowadays have decided to publicly call themselves fiduciaries. Here’s the definition and I’ll let you be the judge of their fiducairyness.
A fiduciary is a person or organization that acts on behalf of another person or persons, putting their clients' interest ahead of their own, with a duty to preserve good faith and trust. Being a fiduciary thus requires being bound both legally and ethically to act in the other's best interests.
I’ve raved and ranted like a lunatic about the asset management industry. Compared to IRDAI, SEBI has done an amazing job of putting in regulations that ensure maximum transparency and prohibit price gouging by the AMCs. Otherwise, the AMCs would’ve never willingly been this transparent or charge the way they currently do. But, compared to the insurance industry, asset managers come off as saints.
The insurance industry is like a malignant tumour, with a few exceptions. The amount of shit they sell and the damage they cause is unrivalled in the nearby galaxies. The insurance industry has no concept of a suitability standard or a fiduciary standard towards its customers. Insurance companies, much like AMCs are sales driven organizations and for them, it’s a sale at all costs.
And the thing about the insurance industry is that it’s humongous. For context, just the AUM of LIC is bigger than the AUM of all the 40 AMCs put together by a margin. For most Indians, the first and often the only investment is an insurance policy. LIC alone has over 11 lakh agents, and the other insurers have lakhs more. With this distribution coverage, the insurance industry has built a gigantic mis-seeling machine. For context, there are just about 10,000-15,000 mutual fund distributors who make decent money.
For most parts, at a conceptual level, except for Term Insurance, Health Insurance, and Annuities, 95% of all the other products the industry sells are outright scams. Pretty much any product which combines insurance and investment in an ideal world should’ve been illegal but we aren’t in an ideal world, are we?
Today, a mutual fund, for all its faults, has strict guidelines on advertising promotions etc. They can’t sell greed, say misleading things, have celebrities endorse specific products, tout Morningstar ratings etc. But insurers don’t have such stringent restrictions. They end up advertising all sorts of misleading numbers. Even today, you’ll see sales pitches for products that advertise 9-10% when a government bond is yielding about 6.2%. But if you actually verify the numbers, these products won’t even give returns equal to an FD, in some cases, savings bank.
And then there are all the hidden charges and the finest of fine print like this:
Given the low literacy levels and non-existent financial literacy, lakhs of people get ripped off every day, especially senior citizens and people with disabilities.
If you go look at the archives of sites like Moneylife, Freefincal, Capitalmind, you’ll see 100s of glorious examples. But I have some immense respect for the amount of creativity required to come with such junk products. It takes some seriously special intelligence to manufacture and sell shit on this scale.
Banks are chief sellers of the garbage manufactured by asset managers and insurance companies. 6 of the top 10 mutual fund distributors are banks. And banks are notorious for selling products with great care and honesty (sarcasm).
Renuka Sane and Monika Halan had published a paper in which they estimated the financial impact of mis-selling by banks. They show that the damage from ULIPS alone is over Rs 2 lakh crores, that’s only until 2012. If you just vaguely estimate till 2020, the damage will be much more than that. This is just ULIPS. If you just mentally estimate the damage by those traditional insurance policies, endowment policies etc., the numbers will probably shatter your brain.
Halan, Sane, and Thomas (2014) show that investors lost upto US $28 billion to mis-selling of unit linked insurance products between 2005 and 2012. Similarly, Anagol and Kim (2012) estimate losses of US $350 million from shrouding of fees by Indian mutual funds.
And they estimate another Rs 2500 crores of damage from hidden fees in mutual funds. Which again extrapolated to 2020, will be more.
The primary business model of most of the investment management and the insurance industry is to sell shit. You take away shit, and they mostly have jackshit left to sell.
There are a few genuine exceptions, people and organizations that do what’s right for the investors and even willingly lose revenues. The trick is to find those. But this isn’t a uniquely Indian problem; it’s global. The irony is while we constantly compare India to Amrika (US), it’s 100 times worse there.
One thing I’ve rather belatedly and after paying a price realized is the importance of saying no when managing personal finances. At the risk of sounding like a pretentious idiot, there’s alpha in saying no.
One of the toughest things in life is getting your personal finances right. Anybody who says these things are easy is talking out of their butts🍑. This can be daunting and scares away a lot of people. This is why a lot of people don’t even bother figuring out their personal finances.
But make no mistake, it’s a matter of life or death, no exaggeration. It’s not easy, it’s not enjoyable, but you have to do it. You have to find some motivation or an easy way to do this. Fear as a motivator works for more, it might not for you and you need to find yours.
But I digress. Let’s say you’re building your personal finance plan - insurance, investments, wills, trusts and the whole nine yards. When you’re evaluating products, it pays to start with the default assumption that every product is useless and scammy. In reality, 80% of all products are and a good chunk of intermediaries are just driven by commissions. Having that sceptical lens is going to save you a whole lot of money, time, and heartache.
And once you have your personal finance plan set, then saying NO is even more important. New money is the lifeblood of the financial services industry. They’ll always be launching some new fancy mutual funds or insurance policies. But it’s rarely been the case that there has been a product that has been dramatically been better than the existing products. I don’t know about insurance, but for most parts, investing is a solved problem. There’s isn’t going to be a fund that’s going to change life for you substantially.
Every time there’s an NFO, I see people asking me what I think about a new fund. I understand the temptation, and I almost invested in some new NFOs myself. But 9.99 out of 10 NFOs are pointless, and it doesn’t matter if it’s an active fund or an index fund. They’re only useful for the AMCs because they can make money, not for you and me.
Life is more than finding a new fund or some brilliant insurance policy. Stop wasting your time constantly being distracted by new shiny objects. You’ll end up making money for the financial services industry. Get high and read Chetan Bhagat’s novels, get drunk and watch RGV Ki Aag or go throw toilet paper on your annoying neighbour’s house. There are far more useful and enjoyable things in life and wasting time on all this crap.
What you probably missed in the previous editions👇
I wanted to write about one more thing but this post as already become bigger than I expected. Though I like going on long rants, will end this here, and I will complete this loop in the next edition.