Unfortunately complexity is a problem we see all too regularly in finance and investment, for the simple reason that complexity sells. Why?
In this thoughtful article, Andrew Linz, a young consultant at Lane Clark and Peacock, challenges accepted wisdom. This article was first published in LCP’s Vista magazine.
Complexity sells- why?
It was early 1982 and The NASA engineers were scratching their heads. They had a very tough problem to solve. They needed to shed another 300kg in weight to get their payload into space, and quickly. The shuttle launch was only weeks away and that extra weight stood between them and getting the rocket and its contents out of the atmosphere successfully.
The solution, when it came, stunned everyone: Don’t paint the fuel tank. Sometimes the best answers don’t require a PhD. In this piece we make the case for simplicity in investment, and explain why we tell clients to be wary of complexity. Often, it can be tempting to go for the most complicated, sophisticated solution to a problem. We’ve all been there.
I’ve got a set of those electric motorised salt and pepper shakers, you know, with the lights? Great they are. Complex investment strategies and funds may require more advanced technical knowledge to understand; and there’s a natural – but dangerous – bias towards believing that strategies which are more superficially sophisticated and ‘advanced’ must also be better.
Otherwise, why have all these clever people gone to all the trouble of creating them?
And in any case, who am I to question the worth of something I am only just starting to comprehend?
Unfortunately complexity is a problem we see all too regularly in finance and investment, for the simple reason that complexity sells. Why? When simple is harder than complex Unfortunately complexity is a problem we see all too regularly in finance and investment, for the simple reason that complexity sells. Why?
- Complexity (in particular somebody selling you something you couldn’t have come up with yourself) feels like real ‘added value’, whereas simplicity can seem too easy – as though you may have been able to do that on your own
- People who understand things you don’t have a mystique around them, and perhaps even an intimidation factor
- To many people, the length of advice and explanations superficially signals effort
- Complexity can feel like being more in control – by understanding and implementing complex concepts you can fool yourself into thinking you’re prepared for everything.
And here’s why you should keep it simple
Complexity can use up valuable time. Investors have limited time to spend thinking and analysing things, so they better spend it well. The motivation has to be to maximise the benefit for the amount of time and money invested. If an investment approach is going to require a material investment in training to understand it and in ongoing costs to monitor it, it takes time away from other things. That’s not to say it’s never justified, only that the benefits have to be expected to outweigh the costs (including opportunity costs).
Complexity can cause you to focus on the wrong things. Complexity can create a fog that obscures, misdirects and leads you to focus on other areas – manager performance, individual investments, stocks or countries. Complexity can lock you in to a particular provider (adviser, asset manager etc) even when they cease being the right option. This can be a really pernicious influence. Once a complex solution is in place, it is often hard to fire the person or organisation that put it there because of a fear that others will not be able to pick it up and continue with it without incurring some form of cost or loss.
Complex solutions can go wrong in hard-to-predict or understand ways. As any engineer will tell you a complex system is more prone to break down, and to do so in ways that may be hard to foresee or diagnose. This isn’t to say simple solutions can’t go wrong too, of course they can! But this is a good reason why a simpler solution should be preferred to a more complex solution, if they can both fulfil the same outcomes.
Complexity can mask fees and costs, which eat away at your returns. Higher fees aren’t always a bad thing, but they do require an investor to pause and question: how confident are we that the value being added is going to outweigh the higher fees? The burden of proof should be set high here, recognising that nothing is certain in investment and a strategy with lower fees and costs will leave a greater share of value in the hands of end investors over the longer term. Here’s the thing. Often simple can be harder than complex. 17th century French mathematician, Blaise Pascal famously said: “If I had more time, I would have written a shorter letter”. We see this time and again in our industry as weighty, bloated reports and long slide presentations are the norm.
Complexity is only a means to an end
Let’s be clear: there will be situations where complexity is warranted. One example is using derivatives to hedge unrewarded risks. In the pension scheme world liability driven investments (LDI) are in many ways complex investments; with combinations of derivatives, bonds and borrowing coming together to form an invaluable tool for trustees to reduce the volatility of scheme funding positions.
Investing the time in understanding LDI has proved to be well worth it. But the important thing here is that LDI is a complex tool facilitating important big picture strategic decisions – reducing exposure to interest rate and inflation risks. Complexity can be worth it if it allows you to achieve broader strategic goals – but if a simpler solution allows you to do the same thing, it may well be the better option.
At LCP we believe the role of a professional adviser is cutting through the world of complexities to provide clarity – a simpler, cleaner framework to process the myriad challenges investors face.
We think investors should always feel empowered to insist on simpler alternatives being offered by their advisers or asset managers, and asking those people to justify complexity wherever it appears.
The sting, for me anyway, is in the tail of the LCP piece:
“Let’s be clear [young Andrew states]: there will be situations where complexity is warranted. One example is using derivatives to hedge unrewarded risks. In the pension scheme world liability driven investments (LDI) are in many ways complex investments; with combinations of derivatives, bonds and borrowing coming together to form an invaluable tool for trustees to reduce the volatility of scheme funding positions.”
LDI seems to me to be a very capital-intensive way to hedge measurement risks. Alternative (and simpler) ways exist to earn better returns over the longer term, but there seem to be very few consultants out there who have the courage or even the experience to argue against their firms’
obsessions with LDI, CDI, etc. Instead they talk of unrewarded risks, by which I think
they mean interest rates (measurement risk again), inflation (a lot of which has been capped in pensions with LPI and CPI), and maybe foreign currency exposure.
I would have more regard for such thought pieces if they were prepared to argue for and against both LDI and alternatives instead of peddling the same, one-eyed view all the time.
But what do I know?
Some examples of unnecessary complexity:
Capital or Initial units
Tax systems which reduce personal allowance with increasing income, rather than being honest and just putting the band rate up.
George, I suspect that you are entering the world of “internal politics” here!