Delving Further Into TPAMs (Part 2)

Today I continue with a recap of my understanding of TPAMs thus far.

I initially understood TPAMs to be investment experts just like pharmacy benefit managers that handle the drug benefit for health care insurance companies. The phenomenon of compounded investment returns is strong reason why investing deserves a dedicated manager whereas financial advisors (FAs) may be too busy with other activities (e.g. raising assets, financial planning) to do this efficiently.

TPAMs are therefore the embodiment of intellectual capital (i.e. “experts”) required to provide a more optimal form of investment management than a plain vanilla approach one could learn from reading a book. The realization that these are “people like me” got me thinking this might be my niche…

…except maybe they’re not.

I now think I was holding the bar too high. My “significant improvement” terminology refers to subpar—not optimal— performance that, admittedly, still trounces the alternatives (e.g. savings accounts, CDs, or cash under the mattress). For this reason it is good even though it has traditionally struck me as bad (see here, here, here, and here).

I struggle with the reality that TPAMs might provide garden-variety investment offerings. As experts, why not chase performance a bit when bolstering annualized return by a single percentage point can result in a vast wealth increase over the course of decades? But as I have discussed, performance considerations are often omitted completely, which leaves us with that significant improvement.

TPAMs may be better described as specialists than experts. An expert is “a person who has a comprehensive and authoritative knowledge of or skill in a particular area.” To me, this implies quantitative analysts, financial engineers, and/or statisticians: none of which are necessarily employed by TPAMs. Regardless of performance [which is conveniently omitted anyway], constant involvement with investment activities results in familiarity and automaticity that makes them quite valuable.

Realizing that both FAs and TPAMs sometimes provide these garden-variety, mediocre investment returns represents the next step in my understanding. This significant improvement still represents substantial value for the end client.*

Regardless of skill level, I think TPAMs can realize economies of scale that [partially] offset their cost. Perhaps they get better commission rates or personal handling of high-volume trades (since they aggregate capital across many FAs) to reduce slippage compared to typical electronic execution.

I still need to study more TPAMs to get a broader view of their offerings.

I should also do a post on what I perceive to be “garden-variety” or “plain vanilla” offerings.

Also left for discussion is whether “you get what you pay for” with regard to [optimal] investment management (hedge funds).

* Repetition is one way I convince myself of things.