I read a book several years back titled “The End of Science”. In it, John Horgan suggested that all of the mysteries of science had been uncovered and all that was left to those in the field was “diminishing returns”. His suggestion that science had reached a sort of cul-de-sac was met with the expected outrage from the community of professionals who believed that science was in fact still a vibrant study with many mysteries as yet unsolved.

Has the same thing happened to the world of finance? 

As David Lee, the physicist from Cornell University, who denounced doomsayers such as Horgan the year he won the Nobel Prize, which coincidently was the same year the book was published recently was quoted suggesting that new science and any worthwhile fundamental discoveries have become incredibly expensive. So it seems has finance.

Even though we continue to read about new methods for generating profits such as hedge funds and the incredible proliferation of Exchange Traded Funds, these all seem to be more expensive varieties of investments available ten, twenty or fifty years past. They offer the investor some additional reward – or thrill – with the same or additional risk and are often, more expensive.

Science has a risk factor. The proclamation that was made by nineteenth century physicists was torn open when Einstein built his theories on what were previously thought to be solid truths. Those “truths” are past successes that have built new fields of quantum mechanics, relativity and evolutionary biology. 

Stop to think about it for a moment. Everything considered a new discovery often only succeeds in redefining old ones, confirming truths that are already in place, and defining thought processes that have become commonplace.

Finance, like science has a risk factor as well. When the index fund was introduced, the markets hailed it as a tool for the everyman investor, an investment that allowed all of the stocks of the Standard & Poor’s 500, a grouping of the largest capitalized companies to be purchased at once. 

As Henry Adams, the early twentieth century historian once said, “No man likes to have his intelligence or good faith questioned, especially if he has doubts about himself”. But investors constantly question their motives and do so with more than a modicum of self-doubt. The question is why.

Adams was also a believer in positive feedback, a sort of building of knowledge based on previous knowledge. But finance, despite its efforts has failed to do much more than charge more for that thinking in the form of additional risk. Even the least savvy among us understands, investments are meant to grow money. Risk, in other words, is not reward in itself.

Do new and innovative ways to index stocks such as ETFs or when esteemed investment advisors such as Robert Arnott offer differently weighted index funds make them worthy of the mantle new and innovative? Hardly. Instead, what it satisfies is an investor craving to be a trader - a profitable undertaking that Wall Street hopes Main Street continues to do – and the per chance hope that this new theory will prove to be the better mousetrap. 

Benjamin Graham opens his tome on intelligent investing with the debate about the difference between investors and speculators and immediately proclaims his frustration at aptly defining the difference. Investing is speculative by nature he asserts yet investors need not approach the investment as a speculator. 

Science though is inherently different than finance. Or is it? Can finance battle reductionism by offering studies of more complex phenomenon such as returns through derivatives and the wide variety of vagaries offered by hedge funds? They might, but only at great risk to those that are willing to invest in such instruments, many of which are still poorly understood.

Can finance offer revolutionary breakthroughs? Wall Street would argue adamantly that the answer is yes but fail to inform the populace that it would only be possible with the reduction of regulations designed to protect those among us who do not fully understand. Those regulations, which always seem to be a focus of such investment luminaries, most recently by Treasury Secretary Henry Paulson and his closed-door attempts at globalizing our economy through the vanquishing of Sarbanes-Oxley, are there for a single reason: protection of the innocent.

Can finance continue to treat theories as if they were backed by empirical evidence? When some new form of investment comes along, such as ETFs have in recent years, Wall Street touts the success of the investment through the outpouring of support, which is based largely on the in pouring of cash. Sector investing has always been available in mutual funds but the frequent trading of them is restricted. Could it have been for our own good?

Is this the end of finance? Are there no new ways of looking at the same old investments? With any luck, the answer is yes. We don’t need more instruments to increase risk while in many cases, diminishing returns in the process.

Relying on corporate governance and the regulations in place makes the “game” more difficult for the real traders. But for those of us who seek to simply retire at an age when we no longer wish to work, have our money outlive us, and be assured that our investments align themselves with those objectives is why we have those rules in the first place. It should be the most important task for whichever party controls the government and the reason you should vote less for your ideals and more for your wallet. The world of finance doesn’t need any more innovation. What it needs instead is a reintroduction, as Graham put it, to the businesslike nature of investing. 

He also suggested that the investor look for satisfactory results for our investment endeavors rather than the much more difficult superior returns innovation often promise. 

This would be the end of finance as it has evolved in recent years. It would also usher in a more democratic and profitable environment for the average investor.

© 2006 Paul Petillo
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