A Curious Encounter with the Sell-Side
With decades of experience in investment banking, this author deeply respects much on the sell side. Of all the good things I can say about their hard-working ethics, diligence, and perseverance, the stand-out aspects are their manners and client-servicing attitudes. Even when the sell-side jibing was one of the favorite pastimes of the biggest investors in the early days of the industry, this writer can write a book full of examples of respect exhibited by his peers.
That’s why we were surprised when we approached one of the known houses to open an execution-only account the other day. Not only were we told, even as a prospective client, that we had to meet them in their office, but after a brief conversation, we were effectively and summarily dismissed. A couple of equally other well-known houses found nicer ways to decline, citing a lack of resources in their operations. There was no interest in the long-term potential relationship, not just because of our current size but because we were a traditional long-only investment house with limited trading volume.
The Broker's Dilemma: Who Pays the Bills?
In an inflationary world where pricing power is visible across industries, one industry that has had no pricing power for decades is the broking community. Commission rates for institutional brokers have been in a seemingly perpetual decline, forcing these firms to chase revenue elsewhere. Commission rates in executing simple buy-sell trades for equity investors have been downward for over four decades. This has forced sell-side houses to prioritize clients who trade frequently, sometimes turning over their entire portfolio multiple times a month.
The other revenue sources for brokers include investment banking fees, structured products, and clients who use leverage. The result? A structural decline in the significance of long-only, traditional investors who only refresh their portfolios every few years and do not utilize leverage. Even the largest long-only institutions, once the most valued clients of sell-side firms before the GFC, are no longer on the priority list. The emphasis is on fast-moving, high-churn investors who contribute to the trading and financing revenues that now dominate the sell-side business model.
Allocators’ Mark-to-Market Dilemma
Markets move fast, but businesses don’t. Listed equities swing wildly, reacting to every headline, central bank whisper, and geopolitical tremor. In the short term, this game fuels excessive volatility, often detached from real business value. The only proven antidote is time. As Bogle argued, long-term returns follow business growth, provided the entry price isn’t egregiously wrong. Valuation matters, but corporate earnings—not momentary sentiment—drive wealth creation over decades.
In an inflationary world with solid nominal growth, pricing power is king. Fisher’s theory of inflation-adjusted returns makes one thing clear: businesses with innovations, strong brands, differentiated products, and disciplined execution pass on costs and preserve margins. Investing in such companies is, ex-ante, one of the best hedges against both monetary dilution and economic uncertainty. Over time, compounding real business earnings outweigh the daily noise of rate hikes, tarriff wars, and speculative frenzies. The answer to market chaos isn’t better timing; it’s better patience.
And yet, long-term investing has lost favor among the long-term investor allocators—sovereign funds, pension funds, insurers, and family offices. In the world where despite the long-term goals, the daily routine involves managing mark-to-market swings, the emphasis on avoiding short-term drawdowns in performance reports. This has led to a preference for two types of strategies, neither of which favor long-only investment funds:
- Illiquid Assets – Investments in private equity and other non-marked-to-market assets reduce volatility on quarterly or annual statements. Liquidity preference is sacrificed in exchange for seemingly stable returns, although historically because of the peculiarity of innovation aspects during the pre-GenAI era, opportunities that were only available to patient capital, and excessive regulations, there were other fundamental drivers for some of these asset classes.
- Downside Protection at Any Cost—The rise of strategies that hedge aggressively, even at the cost of upside potential, has become widespread. In options terms, markets have tilted toward investors more focused on minimizing tail risk than on compounding capital over the long term.
The result? A proliferation of opaque investment products with complex fee structures. As Bloomberg recently highlighted, indirect fees—through high expense ratios, pass throughs and hidden costs—have ballooned. Traditional long-only houses, by contrast, operate on far lower management and performance fees, with minimal cost pass-throughs. Even at GenInnov, despite our size, we cap our expense ratio at an extremely low level, absorbing additional costs—something which is a norm amongst traditional long-only firms.
The Benchmark Mirage and the Zero-Sum Game
Long-only has suffered relentless attacks. They became everyone’s favorite punching bag not just because of their investors’ needs to manage volatility but also because of not doing their job.
Some justified, many not. Incentive structures in competing asset classes, advisors, and intermediaries fuel the fire. The first accusation: long-only underperforms the benchmark. Let’s investigate.
The stock market operates on two fundamental rules as unshakable as the sun rising in the East:
- The average investor cannot outperform the average.
- Daily net inflows into the market are always zero.
Starting with the second one first: in stock markets, investors obsess over inflows or outflows of a select group of investors. Depending on the justifications one is using, it could be retail investors’ flows as a group or in emerging markets, it is often foreign investors bundled together. Every transaction has a buyer and a seller. If the buyer is desperate, the price ticks up. If the seller is, it ticks down. Assuming perpetual rises or falls ignores the zero-sum game (one that is valid in the long-run even when one includes leverage-supported, open positions of structured markets).
More important is the first point. In comparing against the average, what average are we talking about? Twenty years ago, the number of indices produced by a leading index provider exceeded listed instruments globally. Mathematically unsurprising, but it shows how the “average” yardstick is not as obvious as one makes it out to be.
The narrative of long-only underperformance held water. It was measured against the world’s most well-known indices. For nearly two decades, the biggest market and its largest stocks outperformed almost every other major equity basket. The few long-only managers who beat the S&P 500 or NASDAQ often had concentrated positions in well-known, large-cap stocks. Instead of praise, they faced scrutiny about their value proposition for being in stocks everyone knew about.
In this era, long-only faced its biggest challenge from ETF selectors. These intermediaries often charged higher fees than long-only managers to steer investors toward ETFs. Selling the glory of passives was.straightforward They did not need to evaluate thousands of baskets and ETFs, favoring the most well-known, largest US index instruments. If the next decades see the largest market and its biggest stocks continue to outperform, the business investment industry will stay fragile.
Will Long-Only Matter?
So, for brokers, bankers, allocators, intermediaries, or investors, will long-only ever make sense? Bond markets, after four decades of extraordinary returns, have now shown that even the longest outperformance trends can eventually turn. The assumption that past winners will remain future winners indefinitely is flawed, whether at a market, sector, or stock level. Everyone knows this, so let’s look at it differently for the innovation era when disruptions are rising everywhere and unexpected innovations are springing up regularly.
At GenInnov, we strongly see a business world that is rapidly changing in every corner with extremely low visibility of competitive landscapes few years out. Innovation is unfolding globally, and investing should reflect that. China’s recent disruptions were a public example, but similar shifts are occurring across industries. The dominance of today’s largest players will not be eternal—whether due to political, social, or technological pressures.
Alternative asset classes will continue to attract capital, often pushed by intermediaries incentivized to drive commissions. Long-only, by design, does not provide as many layers of fees for intermediaries. But that very feature—its simplicity, ability to reshape with the constantly changing realities and transparency—may also be its strength. When opacity in other investment products reaches excess, attracting the attention of regulators and media, long-only could experience its resurgence for being there doing things sensibly.
A final word: the funniest article this author had written was disallowed by my partner Venky Sethuraman in the middle of 2024. As we anguished a tad about publishing this, we were reminded of that. If anyone wants to receive what we did not publish, do DM us. Happy Valentine's, Everyone.
