It is commonly accepted that “true” economic growth is the growth driven by technological innovation, and it is roughly approximated by a country’s GDP per capita growth. However, as I argued in an earlier post, short-term economic growth numbers could be distorted by monetary and fiscal policy choices. For example, a government may boost short-term GDP numbers by borrowing money through the sale of its long-term debt (say, twenty year bonds). By doing so, it employs the fundamental “time machine” feature of finance, which allows for the exchange of an uncertain future payoff for a certain payoff today. Ultimately, the repayment of the long-term government debt would be driven by the overall economy twenty years from now, i.e. people working, producing, consuming, and paying taxes then. Some of these people may not even be born today – how can we know for sure the number of workers and how productive they will be twenty years from now?
You need money to make money, right? The same 10% return looks and feels very different for a one million dollar investment vs. a one billion dollar investment. Not surprisingly, the competition in the asset management industry for investors’ assets is fierce – there is a lot at stake. How does one convince a potential client to invest in your investment vehicle? Keep in mind that the investment would be made on an implicit promise of future performance, which, by the way, will only materialize after the investment decision is made. Even then, it may require several years of data to truly assess its performance. How do you convince a wary client that the future is bright and that his/her money will be well taken care of? Are you truly sure that the performance of your strategy a few years down the road will meet the needs of the client? Most importantly, how do you differentiate your investment vehicle from others who could be making outlandish claims about their funds’ expected future performance?