Draw what you see

December 18, 2023

Bleary-eyed from all-night software coding sessions in college, I would meander pass the art building on my way home. I always had a love for art but a fear of art professors (completely irrational as they're basically the nicest humans imaginable), but I finally overcame that fear and enrolled in a drawing class. To this day I remember one of those lessons more than any other. In realism, the professor would routinely say "You must draw what you see."

Your brain will trick you. You will try to draw what you think you see. But if you look at the dimensions and the spatial relationships carefully, you see that your mind creates its own reality.

This lesson is endlessly applicable to finance. Your mind can rapidly build its own world around money, and around markets. Adding to the problem, the news media will happily outsource your thinking for you, constructing that world on its terms.

Let's look at a concrete example. In the past seven weeks, the index of small capitalization stocks is up over 20%. Seven weeks! Do you really think all the publicly traded small-cap firms in America have altered the value of their businesses that much in 49 days? Yes, the interest rate outlook has changed a bit, and interest rates are the gravitational pull of finance. But a big part of this is investors are not tethered to a belief system. With an unsettled mind they are easily swayed by media, and media is always standing by to create this sinusoidal effect.

Draw what you see.

Junk fees have been in the political news. I happen to think most of the investment fees charged are also junk fees, though that is not what the politicians are referring to. Hidden fees exist because they generate lots of sales. Here is former energy trader John Arnold, one of my favorite people on X (Twitter), talking about what happened when StubHub tried to be honest:

Why are companies fighting rules to eliminate hidden fees? Consider this case study from StubHub. In 2015, the company randomized 50% of their millions of customers to see the full price while shopping; the other 50% saw lower prices up front but were hit by added (junk) fees at checkout. The effect was enormous. Customers subject to the back-end fees spent 21% more money and were 14% more likely to make any purchase. StubHub, which had started a transition to fully transparent pricing in 2014 in response to loads of customer complaints of hidden fees, reversed this policy and reinstated them after this A/B test.

The problem for the investment industry is that if they stop hiding fees on clients (see a list here), they will have to charge more up front. Then the price is visible. This is how a market is supposed to work, of course! Market participants should understand the prices. But firms in the finance industry fear the StubHub effect. They would have to *substantially* raise their up-front fees to cover what they are doing with commissions and other shenanigans on the back end.

Dan Cunningham