The croupier’s take

The greatest problem facing equity investors today is not the bear market or the weakness of the global economy. Nor has it anything to do with the possibility of war, high levels of corporate and consumer indebtedness, or any of the other problems one reads about regularly in the business pages. The real problem is the low levels of expected returns for most stock market investors. This is due primarily to the high levels of fees extracted by a bloated and parasitic financial services industry. Charlie Munger, the right-hand man of Warren Buffett, refers to these fees as the “croupier’s take.” Let us attempt to gauge its size.

As a starting point, I suggest that the stock market’s future return will be 5 per cent after inflation. This figure is somewhat lower than the historical average but appears prudent in the post-bubble environment. The croupier’s take begins at the corporate level. First, we have the extraordinary compensation of senior executives in the form of stock options. In the US, according to Standard & Poor’s, these were equal to 20 per cent of reported earnings in the 12 months ending June 2002. Bang goes one fifth of expected shareholder returns. We estimate, very roughly, that the fees paid by corporations to investment banks for mergers and acquisitions and other services knock a further 0.5 percentage point off expected returns.

Now let us consider the various charges of the fund management industry. Managers of corporate pension funds normally charge a fee of around 0.5 per cent. On top of this we must add the costs of trading. These include commissions to brokers and stock exchanges, and the “spread” between the bid and offer price of shares. I assume that these costs are roughly 1 per cent of transaction value. US investors pay an average of $30 billion each year in brokerage commissions. Thus, a fund manager with an average holding period of one year accrues annual costs of 1…

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