The Paradox of Skill

With all the amazing changes and “advancements” in finance over the last thirty years, you would think they had figured out how to beat the market. In fact, it is getting harder and harder to beat the market. We call this the “paradox of skill.” 

As more and more technology and more and more expertise is applied to beating the market, this increase in skill paradoxically makes it more and more difficult to beat the market. 

Just as athletes today are bigger and stronger compared to athletes of yesteryear, so to investment managers of today are smarter and quicker than ever before. However, unlike improvements in athletic performance, there are no discernible improvements in alpha (beating the market) by market participants. And not only that, but it requires an incredibly long performance history to gather sufficient data to make any statistical inferences as to whether outperformance was a result of skill vs luck. 

Good luck with that. 

A Rough Estimate

At a pinch, I would guess that the financial services industry has spent more than $2 trillion dollars on information systems, computing power, and investment expertise over the last thirty years. The end result has been a net decline in alpha. Every penny spent has actually resulted in a net decrease in ability to produce above market results. Notch that up to the "paradox of skill."

What would be interesting also, is to gauge how much the industry has spent on sales and marketing. 

One day I am going to take a much closer look at these areas and get a better idea of the money spent (compared to the amount of value added for investors).