Can the market for apples teach us about money management?
Photo: Arly Flo. Source: Wikimedia
Like many people, I grew up with the saying, “An apple a day keeps the doctor away.” Apples are supposed to have all kinds of health benefits—from helping your digestion to reducing cholesterol to improving your memory. And—unlike a lot of healthy foods—they taste pretty good. But I was never really keen on apples. You see, when I was young, pretty much every apple looked and tasted the same. It was a bright, somewhat mealy variety called “Red Delicious.” And they weren’t very delicious.
When I had an apple in my school lunch, I would eat it. But I didn’t enjoy it. The flavor was—um—okay, but nothing to write home about. Apples may have been good for you, but that’s about all they were. And if you went to the store, there wasn’t much choice. There was either Red Delicious, Golden Delicious, or green Granny Smith.
This wasn’t good for consumers, and it wasn’t good for producers, either. Apples were a commodity. One apple was pretty much identical to another. And like all commodities, only the lowest-cost producer makes any money. Any commodity business is brutal. Smaller apple orchards around the country were shutting down. Production was shifting to mega-farms in Washington State, which used mass-farming techniques to become more efficient. In the mid-‘80s, there was a health scare involving Alar, a chemical sprayed on apples to regulate their growth. It seemed like everyone was losing out: producers were going out of business, and consumers got generic, mealy apples grown with toxic chemicals.
Source: Canada Department of Agriculture.
Around that same time, some scientists at the University of Minnesota discovered a better apple—one that really stood out. They called it Honeycrisp, and some farmers started raising them. Hey, they thought: if I’m going to go out of business, I might as well do it raising something tasty.
And consumers loved them. Honeycrisp apples could sell for twice the price of generic Red Delicious. The farmers were able to survive, and even expand. Soon, new breeds were discovered. Now, when you walk into a store, you see dozens of varieties: Gala, Jazz, Winesap, Macoun, Braeburn. Everyone has a favorite. Some times of the year, apples are the top selling item in the store—more than chicken or milk or cereal.
There’s a lesson here. When a market is dominated by a commodity-type product, only low-cost producers can thrive. But pressures mount to ramp up production to take advantage of economies of scale. After all, someone else might sell their goods for just a little less. Amid that pressure, corners will be cut. In this light, it’s no surprise that the largest retail bank in the country had an ethics scandal involving generic banking products. Money is a commodity.
The same pressures are mounting in the money-management industry. Generic index funds are growing and growing and growing. Over half of the publically traded stocks in the US are held by five giant mutual fund families. And they’re efficient. You can now own $100,000 portfolio of blue-chip equities and pay $40 / year in fees. It’s likely we will soon see “free” products created and marketed, the same way consumers can get free brokerage and free checking. Who knows? Maybe some aggressive fund companies will adopt negative management fees—like negative interest rates—making money on the order flow.
But you get what you pay for. Generic products lead to generic performance—the equivalent of Red Delicious portfolio products. And mass-produced goods always come with issues, whether you can see them (yet) or not. People and institutions need customized financial guidance. Everyone is unique—with their own assets, liabilities, income, and tolerance for risk.
The solution for money managers isn’t to become cheaper, it’s to provide a tastier solution. Smaller producers can survive, and everyone can be better off. But only if they embrace innovation.
Douglas R. Tengdin, CFA
Chief Investment Officer