John Kay: Why The Customers Have No Yachts

Having dissected the way that markets work, and before that how companies should, in his latest book the economist John Kay has turned his laser-like attention to the subject of personal investing. One of his themes, the need for investors to minimise the take (in fees and charges) that providers and advisers slice off their returns, was summarised in an article in the Financial Times yesterday.

The book itself, entitled The Long and The Short of It, can be thoroughly recommended to anyone who wants to look after their own money in an intelligent way (although as someone who read the book in draft, and has worked with John Kay in the past, I must declare a personal interest). He puts the Efficient Markets Hypothesis, rational excpectations and all the other influential outpourings of academia firmly in their place – “illuminating but not true”, in his words.

Here is an extract from the article:

“Over the 42 years that Warren Buffett has been in charge of Berkshire Hathaway, the company has earned an average compound rate of return of 20 per cent per year. For himself. But also for his investors. The lucky people who have been his fellow shareholders through all that time have enjoyed just the same rate of return as he has. The fortune he has accumulated is the result of the rise in the value of his share of the collective fund”.

“But suppose that Buffett had deducted from the returns on his own investment – his own, not that of his fellow shareholders – a notional investment management fee, based on the standard 2 per cent annual charge and 20 per cent of gains formula of the hedge fund and private equity business. There would then be two pots: one created by reinvestment of the fees Buffett was charging himself; and one created by the growth in the value of Buffett’s own original investment. Call the first pot the wealth of Buffett Investment Management, the second pot the wealth of the Buffett Foundation”.

“How much of Buffett’s $62bn would be the property of Buffett Investment Management and how much the property of the Buffett Foundation? The – completely astonishing – answer is that Buffett Investment Management would have $57bn and the Buffett Foundation $5bn. The cumulative effect of “two and twenty” over 42 years is so large that the earnings of the investment manager completely overshadow the earnings of the investor. That sum tells you why it was the giants of the financial services industry, not the customers, who owned the yachts”.

“So the least risky way to increase returns from investments is to minimise agency costs – to ensure that the return on the underlying investments goes into your pocket rather than someone else’s”. The message is the same one that Jack Bogle, the founder of Vanguard, has done more than anyone else to promote over the years. There is lots more in the same challenging vein. Anyone who has enjoyed John Kay’s weekly FT column will know what to expect.

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