Technology, demographics and passive investing
When I first started this blog in 2007, the iPhone was two months from being released publicly, Facebook had allowed non students to become users the year before and high frequency trading was just beginning to take over most trading floors. Today, as a result of the freer and faster flow of information due to innovations like smartphones, super trading computers and social media, it can be argued that technology has sped up the pace of historical change.
How has this affected investing? One of the key pillars of active investing is to find companies with “economic moats”- some type of competitive advantage one company has over its competitors. Typical economic moats include a game changing technology, customer loyalty to a brand or high barriers to entry due to the regulatory environment. But in a world were capital and information demands to be free, and corporate spin is frequently and vocally counter-acted by social media, are economic moats not so much moats but small gullies?
Consider that in the 1920′s and 1930′s, the average tenure of a business on the S & P 500 was 65 years. By 1990′s, the average tenure was down to 10 years. Competitive pressures, environmental changes and freer markets makes it hard for any business to stay on top. Consider the words of the consulting firm of Deloitte who noted that the “topple rate“- the rate at which economic moats disappear from industry leaders: “nearly every advantage, once gained, is shown to be temporary. The notion of “sustainable” competitive advantage is increasingly illusive as the pace of change in the business world speeds up.”
Part of the reason why topple rates keep increasing is brand disloyalty is increasing. The younger the demographic, the less the brand loyalty. A generation born with a smartphone attached to their ear are more likely to rely on internet reviews, peer comments and feedback than forming brand loyalty through being the recipient of advertising. As a generation below 20 continues to age (Warren Buffett likes to remark there are 4 million Americans turning 22 each year as a sign America will once again be strong), how likely will the economic moat stocks of their parent’s generation be the economic moat stocks for them if customer loyalty is a disappearing concept (see Blackberry as exhibit A)?
In a world where technology has leveled the playing field, it is increasingly become more and more difficult to pick winners in the stock market. Statistically speaking, it can be done. However, the point of most passive investors is that the chances of falling within the minority of those who can beat a board based market benchmark is small. As technology and demographic trends narrow economic moats, will the percentage of active investors beating the market becoming smaller and smaller?