Monday, September 26, 2022

Smart and Dumb Money

The Journal this morning ran a story about how US retail investors (often referred to as "Dumb Money") have been continuing to buy into falling markets, while institutional investors (aka "Smart Money) have been net sellers. This is a pretty noxious mindset in general. The retail buyers appear to be fools relative to the clever professionals.

Right about now, with markets having become more volatile, I've seen discussions about how volatility creates a favorable environment for "active managers," utilizing their superior judgment to jump in and out of markets at the right time and/or pick the right stocks to outperform indices. Indeed I saw one datapoint "validating" this thesis. Apparently in the first half of 2022 52% of active managers outperformed their indices, the first time that happened since 2009. Clearly, a great renaissance of alpha is underway.

At a macro level, if we prefer capital-markets equity (stock) to debt (bonds) or even bank-based debt financing (loans) or public sector (taxes + government allocation) as the primary way of funding economic enterprises providing private goods, we shouldn't have this snide "look at the stupid sheep" attitude towards those who steadfastly support that funding mechanism through thick and thin. It would be problematic, admittedly, if there is no mechanism for constraint. We can't have everyone just be 100% in stock all the time because it's theoretically the best way to encourage entrepreneurs to try new things. There need to be guardrails and consequences for failure. Honestly that's what the concepts of diversification and investment horizon should provide.

And, of course, all the funding paradigms listed out above are necessary to provide the range of goods public and private we want as a society, each has advantages in different contexts. We've just found over time that a large dollop of equity is part of the secret sauce that unlocks creativity, amongst other things.

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