This article first appeared in Forbes here.
45 years ago, punk was everywhere. From the Sex Pistols almost claiming the top of the singles chart with “God Save the Queen” during the UK’s Silver Jubilee celebrations, to the Clash releasing their debut album, 1977 took punk defiantly into mainstream culture.
Punk was certainly a social and political movement, but it was also a musical revolution. Its antagonists, sick of the prog-rock excesses that ruled the airwaves, wanted something more elemental and authentic. A contemporary fanzine printed a simple guide to playing the A, E and G chords on a guitar. Its message:
After complex products collapsed, investors understandably craved simpler approaches.
“This is a chord. This is another. This is a third. Now form a band.”1
It’s possible to tell a similar story about the rejection of complexity following the global financial crisis. Products were incomprehensible even to the sophisticated institutions that bore their – supposedly low – risk. After they collapsed, investors understandably craved simpler approaches. It doesn’t surprise me that this period marked the beginning of the rush from active to passive funds (Figure 1).
Figure 1. The Move to Index Strategies Accelerated After the Financial Crisis (Net Assets of Index Mutual Funds in the United States from 2000 to 2021, by Index Type in Billion US Dollars)
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Source: Investment Company Institute and Statista; as of June 2022.
To adapt the punk maxim:
“This is an equity index. This is a bond index. Now form a portfolio.”
It worked well, of course. Until it didn’t (Figure 2).
Figure 2. Q1 and Q2 2022 Were Historically Bad for 60/40 (Quarterly Returns of Equities and Bonds, Q4 1998 to Q2 2022)
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Source: Bloomberg and Man Group; as of June 2022.
Simple solutions are fine for simple times (and despite the episodes of elevated volatility during the 2010s – from the Eurozone debt panic to the taper tantrum – this was an environment characterised by easy liquidity and a central-bank put).
Easy Riders Crash
I strongly suspect that many such over-engineered structures are borderline - if not outright - scams.
But what about complex times? Today, we aren’t just dealing with a bear market. We’re facing a downturn that started with no obvious single catalyst that could be addressed, but plenty of interconnected accelerants (spanning inflation, war, rate hikes, and a repricing of risk). Moreover, this is the first major selloff this century when we can’t expect an imminent easing of monetary policy to spur a recovery.
I wouldn’t go so far as to say complex times demand complex solutions. There are still too many over-engineered products with misaligned incentives – not least the so-called stablecoins or the most problematic SPACs. I strongly suspect many such structures are borderline – if not outright – scams.
I greatly admire Morgan Housel, and entirely agree with his observation that – more than in any other profession – financial outcomes are not highly correlated with financial expertise. To quote his must-read book, The Psychology of Money: “Luck and risk are both the reality that every outcome in life is guided by forces other than individual effort. They are so similar that you can’t believe in one without equally respecting the other. They both happen because the world is too complex to allow 100% of your actions to dictate 100% of your outcomes.”
Of course Morgan is too smart to conclude that luck, risk and complexity mean we should dismiss expertise. Instead, I think we need to think in more complex ways while still operating transparently, rigorously and efficiently.
Snap interpretations of market numbers and events were always risky; without the kind tailwinds of the past decade, they have become outright dangerous.
Inflation is a perfect example at the moment. This year, you’ve probably received a multitude of guides to investing during high inflation. You can safely delete them all on receipt – all they really tell you is what has been positively correlated with inflation in the past. What we need to understand is that there are different types of inflation, with accordingly different portfolio implications.
Perhaps you saw some of the (often disingenuous) surprise at the difference in market reaction to 8.5% US inflation readings for March and July. Yes, the headline numbers are the same, but the difference in reaction is explained by the difference in context: between high, accelerating inflation and high, decelerating inflation; between a Fed that was just starting incremental hikes and a Fed that had already turned much more hawkish. And importantly, volatile inflation is more likely to be problematic than high inflation – economies and markets can adjust relatively smoothly if they know inflation will be, say, 5% for a prolonged period; they cannot when inflation jumps around.
Snap interpretations of market numbers and events were always risky; without the kind tailwinds of the past decade, they have become outright dangerous.
Revolution
Writing in 1977, the US presidential speechwriter, columnist and etymologist William Safire claimed: “The success of punk in music and fashion springs from a rebellion against the material success of rebel leaders.”
Which is to say, once revolutionaries win, they become the ruling class and ultimately inspire the next generation of revolutionaries. For the founding punks, it wasn’t just the economic malaise of the late 1970s; it was the bloated music of even their former heroes. “No Elvis, Beatles, or The Rolling Stones” sang the Clash in their track 1977.
Many investors were undoubtedly well served by the revolution from complexity to simplicity in their portfolios through the long bull market. It’s clear traditional stock-picking fund managers suffered in part from the proliferation of access to data and efficient trading platforms. Suddenly the moats of screening analytics and institutional transactions fees were drained, and low-alpha managers found they had no edge! The sophistication of their fundamental process wasn’t so sophisticated after all, and their alpha disappeared. But what they sold was really false complexity – an illusion created by their informational hegemony and deeper pockets. Those that offered true complexity – the type that cannot be replicated on smartphones, like statistical arbitrage or advanced trend following – continued to produce consistently. I expect them to keep doing so now the sun has set on simple beta.
So perhaps it’s time for the revolution to take another turn.
So perhaps it’s time for the revolution to take another turn. After all, the original punks evolved – the Clash went on to draw on everything from reggae to dance, and even Johnny Rotten returned to being John Lydon and embraced avant-garde influences.
So when considering whether to stay with simple portfolios or go, you may recall the words from the Clash classic: “If I go there will be trouble; if I stay it will be double.” There are no easy answers, so we should remember the value of complex thinking.
1. As reported in, for example, Waksman, S. (2003). Contesting virtuosity: Rock guitar since 1976. In V. Coelho (Ed.), The Cambridge Companion to the Guitar (Cambridge Companions to Music, pp. 122-132). Cambridge: Cambridge University Press. doi:10.1017/CCOL9780521801928.009 or Savage, J. (1993). England’s Dreaming: Anarchy, Sex Pistols, Punk Rock and Beyond (New York: St. Martin’s Press, p. 280).
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