The End Of The World As We Know It?

I happened to read two articles in the same week talking about the end of investing as we know it. The articles, “Why It is No Longer a Good Idea to Be in The Investment Industry” and “What Business Is Wall Street In?” were written by two authors, Nassim Taleb and Mark Cuban respectively, whom most would call “love him or hate him” kind of guys. While they are known for stirring up controversy, some of their points seem reasonable.
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In the “Why It is No Longer a Good Idea to Be in The Investment Industry” by Nassim Taleb, he explains the phenomenon that as the number of participants in investing has increased, the number of “lucky fools” increases making it harder for “skilled investors” to outperform the sheer number of “lucky fools” because there are only so many possible allocations. Additionally, he shows empirically (although a bit over my mathematical head) that in fat tail distributions (like the financial market) the phenomenon is amplified making it even more difficult for “skilled investors” to outperform the “lucky fools.”  There are assumptions that may nullify the proof in real life like allocators decision making processes and the assumption that most investors are random returners and not negative returners (worse than random) which opens the door wider for skilled investors. But no matter how you cut it, his overall point that as the number of investors increases, the “lucky fools” will grow in number and make it harder for allocators to look past to the truly skilled players.

The “What Business Is Wall Street In?” article by Cuban describes some of the reasons why investing has moved away from its roots of capital creation and into a market of quick-reflex participants (computers) looking for patterns and temporary arbitrage in the transfer of capital during the capital creation process. This story isn’t new and I’ve heard it repeated by almost every manager I work with, but I do like Cuban’s analogy of Traders and Hackers. The similarities are striking, especially their rationalization of why they do what they do. Also, Cuban has a prescription for getting parts of the market back under control. It sounds interesting, but policy certainly isn’t my forte.

So I come away from both articles agreeing there are distinct challenges for skilled investors from “lucky fools” and “hackers.” But I’m interested in knowing your thoughts. Does the sheer number of investors make it impossible for the skilled investor to outperform the lucky fools and subsequently get funding? Is there a benefit to the system from high frequency trading? If there is no benefit, is it ok to regulate or curtail it? If so, is a tax on high frequency the right call or is there some other prescription? This is a healthy conversation for those that like to think of themselves as “skilled investors.” It seems like something has to give and I really don’t want it to be a sacrifice of those that care about cash flow for the sake of those that care about quote flow.