Return to Sobriety

The last several decades in the investment business have been fun. To be sure the most recent bear market has left a number of professionals on the unemployment lines and they are not smiling. For the most part they had a wealth of experiences in the "good old days" in which their brilliance was recognized and they successfully displayed heroics by making a lot of money, cultivating interesting people, and imagining what it would be like to retire at forty. It was fun for client and agent. Even the government man enjoyed going after the big fraud: the young wheeler-dealer who puts a conglomerate together to snare the naive and the hopeful. The academic enjoyed his self-righteousness in unfrocking the investment specialist with naked computer studies proclaiming "random walk" and challenging the industry to the accountability of cost-effectiveness. Those days have gone.

Work in the investment field is going to be demanding, workaday drudgery. There will be a few places for creative people, but the rest of the business will be staffed by operators. It is going to be like an insurance company: serious, responsible business.

Structural Humpty-Dumpty

The king’s men will not be able to put all the old pieces together again. Instead some new characters will get up on the wall. It is worth listening, for an exercise in anti-logic, to a securities-brokerage leader commenting publicly upon his return from the Virgin Islands where he attended a meeting of the industry to discuss poor profit margins.

The traditional roles of selling by a broker, responding by an institution, and soliciting by a company are no longer appropriate. To talk about what they used to do is not addressing the future but the broken past. No one, NO ONE, of stature in the investment industry points out future needs and new structural requirements. They don’t even admit how the business operates now.

The old pieces are broken and will be left shattered. New entities for swift, inexpensive executions will emerge. Recorded phone messages from company financial officials will replace the expensive company investment visit by jet. Reliance upon quantitative data will place new demands upon accountants for numbers that have some relevance to the investment decision rather than merely satisfying some old adherence to a cost-accounting text.

Costs Will Be Reduced

It is clear that investors are willing to share part of their security profits with the operators of the system. It is similarly clear that they are unwilling to part with their capital base for a job poorly done. If the system is unfair or too expensive, they exercise their option by withdrawing voluntarily. Expenses in the securities industry are estimated at $7 billion including underwriting, commissions, management fees, custody charges, and so on. On a total capital base that may be about one trillion, this figure is an annual seven-tenths of 1 percent toll. If the average annual return on capital is 12 percent, the administrative costs are 6 percent of the annual return—much too high if we are going to work harder at demanding a higher return on scarce capital. A reduction in the proportion of return allocated to the securities industry costs means loss of jobs and firms. There is no way one can reduce $7 billion without lifting badge numbers.

What is a fair number? As a guess, no more than 1 or 2 percent of the annual capital return could be used in support of the capital-allocation system. That estimate implies a reduction of 60 to 80 percent of gross revenues for the securities industry. Yes, the stock and bond markets as we know them today will be dead, but that does not mean that their replacements may not flourish.

Expanded Regulation

Self-regulation in the securities field has failed. Government will take a greater role in the regulatory process and even sponsor change if the industry does not. Specifically, the concept of full disclosure has serious inequities. The interpretation of what is being disclosed varies according to the sophistication of the analyst. Investment practice will be scrutinized by a government agency to see if it is grounded in documentable precedent, a testing procedure not unlike what the Food & Drug Administration requires for new drugs.

Functional Interchangeability

Responsibility for the future course of the investment field rests on the proper balance of government, academia, and institutions. Until now they have been separate, self-serving entities each propounding its special interest. There has just begun to be an exchange in roles through consulting relationships. These will grow to regular job exchanges along the European system of interrelation among business, government, and university. Efficiency will be one result at the expense of competitiveness.

1985

The year is 1985. There is a Federal Stock Exchange located in Washington that is completely electronic, processing capital transfers as electronic pulses at a cost of 1¢ a transfer. The specialist book is on a CRT with instant execution and instant funds transferred by machine. Trading volume is hundreds of times greater than today’s and markets are broad and liquid. The government is a trader in equities for its own account (isn’t it already a ½ owner with corporate taxes and regulation); investors will place orders each morning by machine ("here is what I want my account to look like"); machines will return a calculation on the cost and probability of getting there and the investor will say yea or nay and it is done. Company names in a portfolio will mean no more than division names do now to an investor. They are a means to a portfolio and not the end itself. Clients will monitor the details of a manager’s activity on a daily, real time basis, or hire an inspector to do it for them. All investment activities will be "in the clear" and closely regulated. Money raising for companies will be easy, cheap and instantaneous at the marginal price. Companies can buy and sell their own securities without a special registration with their intentions to purchase an "open hand" like everyone else. This end may justify the pain of transition and the anxiety of uncertainty a decade ago.