Winning the Loser’s Game Comes Full Circle

Posted on August 29, 2012 at 1:42 PM PDT by

Investors love a good metaphor. Bulls vs. bears. A wall of worry. The madness of crowds. One of our favorites, of course, is the classic Charley Ellis tennis comparison, “winning the loser’s game.” We’ll explain in a second…

Now we’re beginning to see the “cruise ship” trade. You know how cruise lines market themselves: Carefree, sun-kissed days, round-the-clock fun, exotic ports of call. And the prices are low, low, low — until you add in the extra cost of excursions, alcohol and, well, just about anything other than sitting in your room.

cruise ships Winning the Losers Game Comes Full Circle

Mutual funds are the cruise ships of the money world. For a low get-in price, you receive the impression of exclusivity, service, and ease. Of course, the fees and expenses become more clear after you board that ship, but by then, well, you’re away from the dock and, darn it, why not have some fun? In the background, of course, the costs mount.

As is the case in all markets, you soon find segmenting. The only way to sell more of any commodity, be it your cup of morning joe or stock-picking, is to price for every possible buyer and then let them chose how much to pay. The basic ingredients of a 90-cent coffee and cream and a $4.75 extra-whip, tall, no-fat superdrink are about the same. One clearly has a better profit margin, but you have to sell both and wait to see who bites.

In our “cruise ship” fund world, segmenting to find price sensitivity is rampant. At one extreme, you find index funds and ETFs offering the steady-Eddie, plain-vanilla experience. Your ship will move neither fast nor slow. It will stop at the same ports as all the others. You will get from A to B with a minimum of rough waters. It’s transportation. You are winning the loser’s game by design.

At the other end, to continue with the ship theme, you have the super-deluxe cruise package: the hedge funds. They’ll charge you 2% for your trouble and take 20% off the top, but you should expect the very best — top-shelf advice, cutting-edge talent, an outstanding experience commensurate with the cost.

Winning the loser’s game, hedge-fund edition

Except something funny happened once we left the dock. As The Financial Times explained recently:

While the industry seems loath to accept the idea that there should be any limits to its size, there are clear problems associated with scale. It becomes harder to devise distinctive strategies. Funds find it more difficult to trade in and out of markets without moving prices against themselves.

An even bigger concern is that size has turned the industry into what is known as a “loser’s game.” This is one in which victory goes not to the player with the best offensive strategy but to the one who makes the fewest mistakes – and has the lowest costs. Hedge fundery has become a loser’s game because the funds themselves are no longer the exotic and small offshoot of mainstream fund management they were in the 1990s. Increasingly, they are the market. (Emphasis added)

Think about what that means. If hedge funds can’t trade without moving the market against themselves, then they are the market. The metaphor has come full circle. Unless you know for a fact that one given manager literally has the keys to long-term riches, chances are pretty high he or she will match, and quite possibly lose, against a rock-bottom index fund.

Nevertheless, you will pay that 2 and 20. And for what? The illusion of advantage? A better view of exactly the same ports of call? Instead, hop on a well-designed, inexpensive set of funds with a decent asset allocation and rebalance as you go. You’ll get to Point B just fine, minus the extra baggage of fees and risk. That’s winning the loser’s game.




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