June 20, 2024

Episode 310 - Professor Antoinette Schoar: Consumer Finance, Crypto, and Private Equity

June 20, 2024

Antoinette Schoar is the Stewart C. Myers-Horn Family Professor of Finance, MIT Sloan School of Management.

She holds a PhD in Economics from the University of Chicago and an undergraduate degree from Germany. Her research interests span from entrepreneurial finance to fintech, consumer finance, and financial intermediation. She has received several awards including the Kauffman Prize Medal for Distinguished Research in Entrepreneurship and the Brattle Prize for best paper in The Journal of Finance.

She is the co-chair of the NBER Corporate Finance group. She has served as an associate editor of The Journal of Finance, The American Economic Journal: Applied Economics, and the Journal of Economic Perspectives.

She also is the cofounder of ideas42, a non-profit organization that uses insights from behavioral economics and psychology to solve social problems.

There is a huge range of factors that can impact our investment decisions, whether we realize it or not, from our level of financial literacy to our political affiliations. This is borne out in research conducted by today’s guest Professor Antoinette Schoar, the Stewart C. Myers-Horn Family Professor of Finance at MIT Sloan. Today, Antoinette joins us to share her insights and challenge conventional wisdom on various topics from target date funds to cryptocurrencies. Tuning in, you’ll learn about the transformative impact of target date funds on investment behaviours and asset allocation, before delving into the subject of financial literacy and financial advisors. Antoinette also sheds light on the unique dynamics of crypto trading and breaks down why retail investors' strategies in crypto differ significantly from those in traditional markets. We also discuss the complexities of private equity and venture capital, focusing on why these asset classes might not be suitable for retail investors due to high barriers and risks. Our conversation also covers the critical role of regulation in maintaining market stability and protecting investors. Join us for a thought-provoking discussion that promises to deepen your understanding of financial markets and enhance your investment decisions!

Key Points From This Episode:

(0:00:18) An introduction to today's guest, Antoinette Schoar, and her extensive research.

(0:03:44) The rise of target date funds in the American retirement system: how it’s affected asset allocation and trading behaviour of retail investors.

(0:09:39) The impact of target date funds: how they have affected mutual fund flows, arbitrage opportunities, market efficiency, the elasticity of aggregate demand, and trend-chasing anomalies.

(0:16:48) The influence of individual beliefs, like political affiliation, on financial decision-making and portfolio adjustments, and how to counteract it.

(0:21:54) Perceptions of risk in housing investments: how this affects the rent versus buy decision, what changes people’s housing risk perceptions, and how to make better housing decisions.

(0:29:29) Findings from Antoinette’s study on financial advisors and their effectiveness at undoing bias in their prospective clients.

(0:33:51) How investors' prior beliefs affect their receptiveness to receiving financial advice and why better financial literacy is essential.

(0:41:38) What consumers need to know about advisor compensation structures and what they should look for when seeking out financial advice.

(0:47:05) How Antoinette’s students motivated her to research cryptocurrency and teach it.

(0:49:40) Antoinette’s insights on the applications of cryptocurrency and blockchain, and some of the surprising positive outcomes from the rise in cryptocurrency.

(0:52:13) The trading behaviours of retail investors in cryptocurrencies compared to traditional asset classes.

(0:57:30) An analysis of the Terra Luna collapse explaining the systemic issues and resulting financial impact on smaller investors.

(01:02:14) The broader implications of cryptocurrency trading and the need for regulatory oversight to protect investors.

(01:06:05) An overview of the challenges and risks of investing in private equity and venture capital for retail investors.

(01:11:56) Antoinette’s reflections on success, professional goals, and the broader impact of research on financial markets and investor behaviour.

Read The Transcript:

Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We are hosted by me, Benjamin Felix and Cameron Passmore, portfolio managers at PWL Capital.

Cameron Passmore: Welcome to episode 310. Ben, you and I were just laughing about how our guest characterized herself as a boring economist, and you and I agreed, and I'm sure the audience will agree that this conversation was anything, and she is anything but boring. What a great conversation with Professor Antoinette Schoar, who is the Stewart C. Myers-Horn Professor, Family Professor of Finance at MIT Sloan School of Management. This is a super wide-ranging conversation about all sorts of topics, and you have to get the backstory. I know I always ask you this, but there's always a backstory to these conversations, and you got to carry it from here. She was great.

Ben Felix: I don't know how much of a backstory there is, other than I've been aware of Antoinette's research for a long time, as I think anyone that studied financial economics would have to be, because she's done ground-breaking research on private equity. She's also done stuff on entrepreneurial finance, fintech, consumer finance, financial intermediation, household finance we spend a lot of time talking about, but tons of huge, huge research, big influential papers.

I just knew we had to have her on eventually and finally asked her to do it. We did have her co-author on some of her more recent research on crypto, Igor Makarov on the Rational Minder when we did our crypto series, so there was another instance of me being aware of Antoinette's impact on financial economics. I agree with you, Cameron. This was an awesome conversation. I was just thinking, as we were finishing the conversation, how grateful I am to be able to talk to people like that because of the podcast.

Cameron Passmore: Absolutely.

Ben Felix: It's just, you don't talk to people like that in normal day-to-day life. You just don't.

Cameron Passmore: And listening to people like her. And she said it, financial literacy is so important, especially in the decision of how you choose your financial advisor to make financial decisions. Great research on that. Talked a lot about target date funds, perception of risk and house prices. Fascinating research there.

Ben Felix: It's all fascinating. I really appreciated how, when we would ask a question about her research that we clearly read the research and understood some of its implications and asked a question based on that, she loved it. She's excited to talk about her research, which is just so cool. I mean, I think all of our guests probably are excited to talk about the research, but I just found it to be a very energizing conversation on some really cool topics, too. We had target date funds, like you said. We had how an individual's beliefs affect the way that they respond to new information, which is also just fascinating to think about how people make decisions. Then there's some on the perception of house price risk and how that affects the rent versus buy decision. That was also super interesting.

Then a bunch on, she got two papers on financial advisors; one that's been out for a while and one that I don't even know if you can find it online yet, but when I sent it down to my first pass at questions, she was like, “Oh, well, you should look at this brand-new hot off the press paper, too.” Okay. Awesome. We asked about that one.

Cameron Passmore: Then at the end, you snuck in a couple of questions on private equity.

Ben Felix: Private equity. Well, crypto, too. We had a whole section on crypto and her thoughts on that were super, super interesting, and then snuck one in on private equity, which like I mentioned earlier, that's an area that she's done some great research on both in the past, but some more recently, too. Anyway, wide ranging in terms of the topics, but I think this was a great conversation that I think the listeners will thoroughly enjoy.

Cameron Passmore: All right. Good to roll?

Ben Felix: Yup.

Cameron Passmore: Here's our conversation with Professor Antoinette Schoar.

***

Ben Felix: Antoinette Schoar, welcome to the Rational Reminder Podcast.

Antoinette Schoar: Thank you for having me.

Ben Felix: Super excited to be talking to you. Antoinette, to kick it off, how important to have target date funds become to the American retirement system?

Antoinette Schoar: Actually, quite important. It's almost a little bit of a serendipitous situation that they were introduced as a solution to a default allocation in 2006 and have grown from there, but they really have had a very successful rise since then.

Ben Felix: How have target date funds affected the proportion of wealth that households invest in the stock market?

Antoinette Schoar: That's actually a very interesting question, because you see, they haven't necessarily affected how much people put into retirement savings. According to research I have done with my colleague, Jonathan Parker and PhD student of us, Alison Cole, we actually see that they don't necessarily increase the amount people save, but the way that people allocate their retirement savings. It has led to a situation where basically, people are now, especially in young age, putting more money into the stock market, therefore, in a way, taking more risk. When people become older, these retirement saving targeted funds automatically allocate more and more into less risky assets, like fixed income.

We see, basically, that with age, people are therefore, then allocating more to bonds and fixed income and less into the stock market. That has changed really dramatically since the introduction of target date funds.

Ben Felix: It hasn't affected savings behaviour, but it's affected asset allocation behaviour. What were people doing before? What's the difference?

Antoinette Schoar: Yeah. The difference, interestingly, was that before, so say before the 2000s, people didn't really reallocate their savings over their life cycle. Even, say, older people that were close to retirement in a way got stuck with the same allocation that they were in when they opened the account. In addition, we also saw that in the past, people actually allocated much less on average to equities. In the pre-2000 period, the average person had more around 40% to 50% of their retirement savings in equities, and we are finding that people have almost 70% in equities nowadays.

Ben Felix: Interesting.

Cameron Passmore: Very interesting.

Ben Felix: That's probably a good thing.

Antoinette Schoar: Yeah. It's a good thing in the sense that we know that there's an equity premium. Because you're taking risk when you're investing in equities, on average, investors want to be rewarded for that risk that they take. Therefore, are expecting to have a higher return on the risky part of their portfolio. Now, of course, they're taking risks. If you are unlucky, and we've seen that, unfortunately, the market sometimes goes down. If you are hit with one of those negative shocks close to your retirement, then you have very little time to make it up, if you want. That's why we often think that it is sensible that people take less risk when they approach their retirement date.

Cameron Passmore: How have the target date funds affected the trading behaviour of the retail investor?

Antoinette Schoar: Actually, at least according to our research, not so much. This might be somewhat surprising to you, but the reason is the following. The average American, unfortunately, actually, looks at their retirement savings, their 401k, very rarely. In fact, we find that people actually look into their retirement accounts as little as on average, once every one and a half years. That's shocking. People are not day traders in their retirement savings accounts. In fact, I would say, they're maybe even looking at it maybe too little, because you want to be aware of what you're doing in your retirement.

Now, of course, there are people who have brokerage accounts and so on, and they are trading quite a lot in those accounts. But in their retirement and 401ks, it hasn't affected people's active trading. You see, in a way, the target date funds were meant to help with the fact that people pay so little attention to their retirement savings. What the target date fund does is that when, say, the stock market goes up a lot, it automatically rebalances you a little bit out of stock and more into fixed assets, so that you're back to your target allocation for your age group.

Given that we see, even an hour later, that in the past, people didn't do that. When the market say, would go up a lot, they were suddenly very skewed towards equity. Or when the stock market went down and out, they suddenly had very little in equity. That's obviously not so.

Ben Felix: Basically, people didn't used to rebalance and now they do.

Antoinette Schoar: Exactly. It helps them. They are not doing it actively, but they're being helped in doing it.

Cameron Passmore: A one-and-a-half-year number is a staggering statistic. The average is one-and-a-half years.

Antoinette Schoar: It's staggering, indeed. Unfortunately, in our data, at least this research that we did, it's all people that have a 401k. I can tell you, I've talked to a lot of 401k providers and they also say, there are people that are so maybe uninformed, or they don't get the act together and they don't even open a 401k. Even if you are at an employer that has a 401k and has a match, then you are really losing out. Those are things that are reserved, which is the regulator of the retirement saving system, but also the 401k, by allowing more default allocations to targeted funds, again, was trying to help people to start investing even when maybe they themselves wouldn't allocate the money in a smart way, or other.

Ben Felix: What about mutual fund flows? How have target date funds affected that?

Antoinette Schoar: That's a great question. At least it's something that's very close to my heart, because I've been doing research in it. Actually, what's interesting is if you think about what is a target date fund? A target date fund is almost like a construction on top of a set of mutual funds that are equity and fixed income mutual funds. What the target date fund does is, as you were just saying, it rebalances you in actually a counter cyclical way.

If the stock market goes up a lot, and without rebalancing, you would now be too skewed towards equity, what then happens is the target date funds sells some of the shares from the equity mutual funds and buys a bit more from fixed income. The other way around, if the stock market goes down and therefore, you now have less money, then you should in terms of portfolio balance in equities, it actually counter cyclically buys equities when the market has gone down. That's actually completely the opposite to how the typical retail investor invests in mutual funds.

We know from a lot of research that retail investors chase returns, meaning that they actually start buying more equity mutual funds when equities have done well and the other way around when equities have done poorly. It has really changed the flow behaviour into mutual funds.

Cameron Passmore: How have they affected individual stock prices?

Antoinette Schoar: That's also a good question. A market, there's demand and supply, there are changes in prices, so it's an information that people have. It's not so easy to estimate how some flows, such as targeted funds, affect individual stock prices. In aggregate, anyway, it's very difficult, typically addressing it, because so many things go on in the market all the time. One thing that we were able to exploit in our research is that actually, target date funds tend to be skewed in the stocks that they allocate towards to larger and more liquid funds. They are more likely you say, to be heavily invested in S&P 500, in the basically, largest and most liquid stocks.

What we are then able to do is to look at stocks where target date funds became really important holders of those stocks and compare them to stocks where target date funds are much less likely to allocate to. What we see is actually, that even just in the last 10 years when target date funds were growing quite a bit, we see actually that the stocks where the target date funds are very prevalent, their returns are actually now much more stabilized. Basically, the up and down, the movement with the market of those stocks is muted for those that target dated funds are holding.

That makes sense, given what we just said, is that because target date fund counter-cyclically invest money when the market is down in equity and sell equities when equities just have gone up a lot, then it would make sense that we would see that type of pricing behaviour. In other ways, you could almost say that it has muted the type of market-based momentum that we see often for stocks where retail investors are chasing rate.

Ben Felix: Would the price effects from target date funds create any arbitrage opportunities?

Antoinette Schoar: That's a very good thought. We looked into this, and [inaudible 0:13:26], it could have been, but we couldn't find. What we at least show in our research is that for the last almost two decades when target date funds were growing, if you were trying to trade against the target date funds, you would have actually lost money. Now, going forward, if they become even bigger and maybe their price impact becomes even stronger, that could change, but we didn't find that you could really arbitrage against them.

Cameron Passmore: What effects do they have on market efficiency?

Antoinette Schoar: Right now, we can only speculate a little bit about this, but it's actually not clear whether they are helping, or hurting efficiency. The reason why I'm saying this is the following. If you think that some market movements, or let's say, that in situations where price movements are based on price revelation and new information, the fact that the target date fund trades against those price shocks, actually makes it harder for the information to get into the market. In those situations, actually they would make markets less efficient, because it becomes slower for the price to move where it needs to move.

If you think that there are also situations where the market sometimes overshoots, or there is basically behavioural reasons, or meme stocks, there are very few meme stocks, obviously, but they can be cyclical movements. Then it might be actually that target date funds increase market efficiency, because then they are leaning against these type of overshooting behaviours.

Ben Felix: We had a recent guest who drew the distinction between market efficiency and market elasticity. He was talking about his concerns with the growth of index funds in particular. How do target date funds affect the elasticity of aggregate demand?

Antoinette Schoar: At least in our research, we think that it actually increases the elasticity of aggregate demand, because there is now much more rebalancing in response to price movements.

Cameron Passmore: What do your results suggest about the future of momentum, or other trend chasing anomalies?

Antoinette Schoar: At least in the time period that we have looked at, it seems to actually lean against this type of price chasing behaviour. We think that if targeted funds grow even more, it could even be stronger. Despite what we just discussed about, does it affect market efficiency, and so on, I think for the average retail investor, typically, this type of momentum chasing and trend chasing actually has been shown to not be necessarily good. They actually lose money this way. I think, it's probably on net, better for retail investors if they are not return chasing and rather have a more automated solution that helps them rebalance, where they may be actively wouldn't do it.

Ben Felix: Oh, that's interesting. Target date funds might kill the momentum anomaly in the data, but overall is better for retail investors, because momentum exists due to return chasing, which is probably destructive to the individuals doing it.

Antoinette Schoar: Exactly.

Ben Felix: That is super interesting. Okay, I want to move on to some other research. How do people's individual beliefs, like their political affiliation, which you look at in a paper, how does that affect how they change their portfolio in response to new information?

Antoinette Schoar: We looked at this actually, residential elections in the US. Exactly as you just said, political election, like Obama being elected, or then Trump being elected, these are information that in a way, everybody in society learns. This is not a situation where somebody has preferential, or private information. That's why we thought it was interesting to look at these highly publicized events, where the information itself is available to everyone, but different people might react differently to it depending on what their prior is about maybe that type of economic policies that say, a Republican, or Democrats with [inaudible 0:17:33] and our president would enact.

What we find, actually, is that if you look first at the Trump election in 2020, and we see actually that people who are democratic leaning and people who live in zip codes that are heavily democratic voters, react to the news of Trump being elected by pulling out of the market. Republican leaning voters and investors are moving into the market. Now, what we thought was interesting about this is actually, remember what we said before how little people look at 401k, unfortunately, actually? In this case, maybe it's a good thing, because what we see is that it's about 10% of the population react really strongly, and puts actually, quite a lot of money either out of the market, or into the market.

The majority of people doesn't do very much. What I thought was interesting is if you look at opinion parts, like the Michigan Sentiment Survey and so on, when Democrats and Republicans are asked about, how do they see the future of the economy in response to these political elections? When Trump got elected, Democrats were saying, it's the end of the world and Republicans were saying, it's the second coming. Then if you look at the similar thing when Obama was elected, just flipped but the same thing.

What I think is quite interesting is that it seems to me, it's probably cheap talk how you answer a survey question. It's easy to say in a survey question, “Oh, my God. This is the end of the world,” or whatever. When you have to put your money where your mouth is, it seems people are much more careful. Maybe that's a good thing, because in the end, it shows that people in the things that really matter have a slightly more balanced view of what different presidents mean for the economy.

The other thing I just want to say, which you also thought was interesting is women, because in general, women's political beliefs don't seem to be as strong, or maybe as ideological as men are. They also react less in this polarized way in their savings behaviour. They are in a way much more moderate also in how they react to these political information.

Cameron Passmore: How can people avoid letting their beliefs get in the way of their financial decisions?

Antoinette Schoar: Wouldn't we all like to live in that world. Not just in savings. I think it's being wiser. But this is not a finance answer, sorry. In finance, what we see in the data is actually two things. We do see that people who use financial advisors tend to react much less strong. I think it's because financial advisors are meant to, indeed, lean against some biases that you might have and help you stay the course more. We also, by the way, see that people who have much more money in target date funds tend to be also less likely to be pulling out of any people.

In general, I think, obviously there is one thing about your political and ideological beliefs and there is another side is being rational about what move stock markets. I do think that's just something that hopefully, people learn. By the way, let me say one other thing. We do see, because if you remember during the Trump campaign and then after Donald Trump was elected president, capital gains tax were reduced significant. No matter what political belief you have, you do have to understand that say, lower capital gains tax do normally get capitalized into prices. No matter what your political belief is, that's something that you should react to. We see over time, also democratic voter, indeed, do then start allocating more to equity again by the time.

Ben Felix: Yeah, that's all super interesting. We're in Canada, but we definitely have calls from clients when Trump was elected who wanted to get out of the market and go to cash. I remember that and we were the barrier to stop them from doing that. I want to move on to perception of risk in housing. How much variation is there across households in the risk perception that they have of housing as an investment?

Antoinette Schoar: That's research that I have done with two other colleagues of mine, Manuel Adelino and Felipe Severino. We were very surprised, actually. This is based on survey data, where the Fannie Mae has a survey, and then the New York Fed also has a survey that asked a representative set of households about their risk perception of house prices. Why we were so surprised is that the majority of households actually believes that house prices are not very risky. That was even true, because the service got started after the great financial crisis. They got started in around 2009, 10, and then the fed survey a bit later.

Even directly after the financial crisis, after we've experienced such a big shock to house prices, when people answered about their perception of house prices, they thought that house prices are less risky than diversified mutual funds, and even fixed income, meaning bonds. That's really stunning. You see, I think it's maybe that people somehow, because they might be over-optimistic about their own house, you know your house, you maybe like your house, you feel that if I just keep my house in tip-top shape and my garden beautiful, I can always sell it, and so there is not so much risk.

Unfortunately, the data obviously tells something very different. To me, as you can hear from my accent, I'm not born in the US. I'm from Europe. I'm from Germany, which is a country that has a much bigger rental market and people live very happy being renters and not necessarily having to be exposed to such a big and illiquid asset when they might be lower middle class, and therefore, it's maybe better for them to save in a different vehicle than a house.

Cameron Passmore: I want to keep going in this rental question. How do individual perceptions of the house price risk affect their rent versus buy decision?

Antoinette Schoar: We do actually see that it does. We see that people who think that house prices are risky and have volatility, they tend to be more likely to be renters than owners. Because there are people who are renters for completely different reasons, right? When you are young and you're still in school and you're not settled down, it makes no sense. That in two years you're moving anyway. Or when you have, say, little savings and very volatile income stream, you might not want to take a lot of leverage and buy a house.

Even after you control for all of these, we do find that people who are in a way, concerned about house price risk tend to be renters in the US. That makes sense, of course. In a way, there are a few people who are really concerned about house price risk. A majority of people basically seems to believe that housing has very little prices.

Ben Felix: Could the people who think housing is not risky have read about the hedge argument, that houses hedge your housing consumption, so it's a different way of thinking about risk?

Antoinette Schoar: If that's true, of course, they should be hedging rent price risk. We looked at, say, even in neighbourhoods where the rent to buy ratio is more, or less favourable, we don't find many differences there. We think that it doesn't really look consistent with the hedge argument. It seems more maybe that people are not fully aware of how much risk there is actually in prices.

You see, one thing, and this is just an educated guess, but I wonder if what happens is that people think about risk when it goes up frequently. They think in stock prices, there's a lot of volatility day-to-day and week-to-week. House prices, you don't see it so much, because when a shock happens, it happens once in a while. Maybe what people don't take into account is that it's exactly when those shocks happen that you might want to sell. Then you cannot sell. It doesn't matter that day-to-day, there's not so much volatility. It's when you need it, the liquidity is not there. Unfortunately, that's what so many households suffered during the 2008-2009 crisis, when house prices had dropped, then mortgages were under water, they couldn't re-level, and then maybe even lost their house. This obviously, was a very horrible time for a lot of houses.

Ben Felix: What changes people's housing risk perceptions?

Antoinette Schoar: We do find that past experience of house price risk does seem to change it a little bit. There's also work by other researchers that have looked at the amount of risk that you experience early in life seem to have some formative and persistent effect on people's aversion to these type of risks. Ultimately, it seems that at least in housing risk, they don't adjust very significantly to the actual risk that there isn't.

Cameron Passmore: How can people use this information to make better housing decisions?

Antoinette Schoar: I would say what's important for people to understand is that from every research we have seen, and there's a lot of research, it's not my own research, going back, of course, to Bob Scheller's work, and Jim Potova has even worked in the 1990s, such as this. So, house prices, not just in the US, but actually, it's really across the world, seem to have a very strong mean reverting cycle. There tend to be these periods of exuberance where house prices really go up and they typically mean revert. Then they go down quite a bit, and then they actually also mean revert on the way up and come back up.

I think, this is very broad advice, I know. I think one should be really, really wary to be buying houses, especially say, with a lot of leverage, and when you maybe put a lot of your savings into it, at the peak of a cycle, or when a cycle, of course, you never know whether it's already the peak, these exports. But when a peak has been going on for a long time, it would be good to be very careful.

In fact, there's very nice work by Monika Piazzesi, for example, at Stanford, who actually looks, again, at survey data from the US. What she shows is that if you look at the great financial crisis, in the run to the crisis, actually, the majority of American households by 2006-2007, was becoming very nervous about house prices. Actually, when answering questions about perception of future house price rules, we're saying, this cannot go on. There was a small subset of the population, about, I think, 15% in her data, that became really exuberant about house prices just in 2008. Most likely, these are people who then bought. I think even looking at how, say, sentiment in the population is changing can help you identify when we are coming close to the peak of an exuberant cycle.

Ben Felix: We're in Canada. I mentioned that earlier. It keeps looking like we're at a peak here, but I don't know when it's going to turn around. I think everyone in Canada would love to know where the mean is. You got a couple of great papers on financial advice. In your audit study on financial advisors, how well did they debias their prospective clients?

Antoinette Schoar: We did an audit study of financial advisors in the US where we sent, in a way, mock clients, if you want, to different financial advisors. These different clients had different portfolios that present different biases. For example, some of them were return chasing, some of them were under diversified and held too much of their company stock, meaning the company where they're working, which is not good for having a well-diversified portfolio location.

What we saw is that financial advisors debias their clients when the decisions that people then would make benefit the advisors financially. For example, if a client holds most of the money in their own company's stock, that is bad for the client, for sure. It's actually also, something where the advisor, by helping the client, makes money, because the advisor can tell the client, move away from that one stock, diversify and buy a mutual fund, where they then benefit from the compensation.

Unfortunately, we saw that when clients have biases where the advice would go against the financial advisor’s incentive, then they do not debias. What do I mean with this is say, there are some clients who think you should be chasing different industry returns, or different subsets of the fund strategies, those costs, in some sense, useful clients to financial advisors, because you can rebalance their portfolio all the way and push it from one type of fund to another. Each time, basically, get fees as an advisor. There, unfortunately, we saw that advisors didn't give people, say, the advice to just invest in low-fee index funds, because that's not so much in their own personal interest.

Ben Felix: That suggests conflict of interest affecting the advice?

Antoinette Schoar: Absolutely. Yeah. You're saying it very eloquently. Basically, yes. It means that it affects advice. But I didn't want to say it, because I don't want to be bludgeoning advisors either. I mean, it is true that in situations where the advice is, in a way, doesn't lead to a conflict of interest, they did give good advice. In a way, I would say that one of the problems actually is that we have maybe in the US in particular, too many financial advisors that actually are brokers and not fiduciary advisors.

In the US at least, there's a difference that if you are a broker, you don't have a fiduciary responsibility to your clients, you just need to not defraud them, basically. It's a very minimal responsibility. While registered investment advisors who are fiduciaries, they actually need to make sure that they put you into the lowest fee funds and act in your interest. Unfortunately, in the US, less than 10% of professionals who act as advisors are actually registered as fiduciary advice.

Ben Felix: In that honest study, how did the advisors line up with portfolio theory?

Antoinette Schoar: I would say, on a minimal basis, it wasn't too bad. Now, this sounds somewhat circumspect, but what I'm trying to say is that the majority of advisors actually did advise people to put money into mutual funds. Therefore, at least there was a minimal set of diversification of the portfolio that these advisors actually recommended. I would say, they didn't give terrible advice.

Where the problem came is more really, that they were not necessarily always putting people into the type of mutual funds that have the lowest fees. They are erring on the side of putting people into actively managed funds. We know that actively managed funds often have very high fees, without doing better than an index fund. This is the margin where I feel retail investors should be very vigilant, if you want. They should understand that typically, a low fee index fund is really the best allocation that they can do for themselves.

Cameron Passmore: How do investors' prior beliefs affect their receptiveness to receiving financial advice?

Antoinette Schoar: That's a very good question. I would say, from some of the work that we have done is that this is actually a relatively subtle answer and the question is subtle. In the following sense, you will often hear from financial advisors in the market that somehow, you have to cater to people's beliefs. You have to basically, just tell them what they want to hear and you cannot educate people. It's a little bit condescending, but it's also very self-serving, because it basically means, if I give somebody somewhat some optimal advice, it's not my fault. It's because the client wouldn't understand better. From my research at least, that doesn't fully line up this, what we are finding, because what we are finding is that when people have more financial literacy, when they know already some finance, they actually want to get advice that is more aligned with textbook advice. Meaning, they actually expect advisors to tell the clients that they need to be well diversified, minimize fees, not go into active funds.

Actually, in those situations where the client has these strong priors, it's when they are more sophisticated and then they're expecting better advice. However, what we find is that the type of client who has very little financial literacy, they actually are very manual. It's not the case that you need to cater to them much, because actually, whatever the advisor tells them, the client is typically willing to believe. Now, for the client, that's not so good, because it means if they're getting bad advice, they are just moving into that advice as happily if you want, or as easily as moving to the good advice.

Actually, remember the argument we started with is that you have to give the client what they want to hear, and there, the argument just know, because the client doesn't know what they want to hear. They don't have much of a prior. They are very willing to accept good advice, too. There's, in a way, no excuse to give these clients very biased, or distorted advice. They weren't waiting for distorted advice. I do want to say one thing, which is probably true and that I've heard from many advisors and even I see this in my own students, it is true that when the market becomes very hot, or when there is basically, a certain asset classes, are very rapidly as people like to say, but basically, when there has been a run, it is true that then there is a lot of temptation for people to, in a way, follow those trends.

I think, probably, it is true that a good advisor who understands their clients well does need to put a lot of effort to explain to people that now, look, these are exactly the times where being diversified and not breaking your portfolio allocation, it feels like, “Oh, my God. I'm missing out, because crypto is going through the roof.” But if you go then into crypto, it will crash on you. Then hindsight is unfortunately, very painful.

I'm not trying to say that it is easy for financial advisors to explain to people what good advice is and why you have to have discipline in your portfolio. I'm not belittling this. All I'm saying is that it's not the case that somehow, especially financially uneducated customers have crazy beliefs and cannot be persuaded of more rational financial strategies.

Ben Felix: People with high financial literacy have a prior that high fees are bad, index funds are good. Then people with the low financial literacy don't really have any priors and are receptive to advice. How does receiving advice change the priors of each group? If you take a financially literate investor who believes in index funds and put them in front of an advisor that says, “No. Actively managed funds are good.” How does that affect their beliefs, and then likewise for people with low financial literacy?

Antoinette Schoar: What we found is that for the people that have high financial literacy, and you tell them the opposite, they actually dislike the advice. They basically down date on the advice and they don't change their beliefs very much. Now, for the people with low financial literacy, we basically see that yes, they react to the advice that's given and they move their priors in the direction of the advice, whether it's good advice or bad advice.

Ben Felix: You did this experiment where people receive advice, and I think there was an activity where they had to actually choose to invest their own money and there was a prize, or something, a contest. How does the advice that they received affect how they actually invest their money?

Antoinette Schoar: We do see that the advice that they receive affects how they invest their money. What I mean with this is that, again, we see that financially more literate people are more likely to pick index funds and low fee funds, and financially less literate people are more likely to also pick active funds and higher fee funds. We do find then, however, that the advice people follow, or change their investment behaviour in response to the advice. We think that even though people, even very financially educated people might on paper understand that you need to be diversified, that you need to pick index funds, that you need to pick low fee funds. But when given actual funds to pick, they don't necessarily know what that means.

There's a big difference between knowing that you should be well diversified and knowing how to build a truly diversified portfolio. Is it 10 stocks? Is it 50? How much do you allocate to each, basically, stock in the market portfolio? This is obviously in a way, more difficult than just knowing the concepts. I think this also highlights in a way, that financial education goes a long way in helping clients and average people know what to ask for from an advisor, but they still need to rely on the expertise of the financial service industry in really implementing those strategies.

Ben Felix: Yeah, it's a big insight. People can get the general concepts and that puts them in a much better position to receive advice, but it doesn't necessarily imply that they can just go and do it themselves successfully.

Antoinette Schoar: Why would be expect? We don't expect people to do appendicitis on themselves. If you want doctors who can tell you what the right diagnosis is, and then do it for you. In a way, financial services is very similar to any type of expert service.

Ben Felix: But it does highlight how important financial literacy is for someone to be able to detect when they're getting bad, or conflicted advice.

Antoinette Schoar: Exactly. Because I think to me, this is a very important dimension that also, regulation needs to be aware of, is that the market for financial advice, of course, is meant to be a private solution in a world where, yeah, financial decisions are complex. Choosing a good advisor needs already literacy. How to pick a good advisor is in a way, one of the biggest decisions that actually retail investors make. I think in the US, at least, it's often very much left to retail investors without much help. Again, because as we were discussing before, most professionals who give advice have very minimal fiduciary responsibility to their clients.

Cameron Passmore: How does advisor compensation affect how their advice is perceived by the consumer?

Antoinette Schoar: What we find in our research, so in the US, there are different models of how advisors are compensated. A majority of advisors is basically compensated by fees that they're getting from the mutual fund providers to whom they allocate clients’ assets, and that creates the conflict of interest, of course. Now, there are also models, for example, where advisors are paid just by time spent with the client. Then what you also find is especially for much wealthier clients, that advisors are paid by assets under management.

Then, the incentives are obviously much more aligned. The issue is often, that in the market for financial advice, there are lots of financial service companies that are marketing their services as saying that the financial advice is free. But it's not free, because the advisors are paid by back-end fees that those mutual fund providers are providing to the advice company. The problem is then the following, what we see in our experiment is that when customers are being told that the advisor has a compensation scheme that conflicts with their interest, they're actually reacting less to their advice.

In a way, that's very rational. They basically realized, “There could be a conflict, so I should take everything with a bit of a grain of salt.” If the advisor is very well aligned with the client, they're much more willing to believe it. That's, again, great in this experimental setup. What I'm a bit worried about is that in the real world, where you have a lot of advisors who will market their service as if they were for free, many consumers might not understand that in a way, you have to pay for advice.

Therefore, an advisor that says, “Look, I do need to be paid, say, for the time I spent with you and for my human capital and the effort I put,” then it suddenly might seem to an informed retail investor, “Wait, this guy is willing to give it to me for free and has also a lot of beautiful slides and talk and blah.” This person says, “I have to be paid.” Then it sounds almost like, this person is taking advantage of me, even though no, this is just the honest advisor who tells you how they are being paid. This leads to, potentially leads to some adverse effects of competition in this market when customers are not fully understand how actually, different advisors are being compensated.

Ben Felix: Yeah. Well, that's important. Consumers, given the information about how the advisor is being compensated, they'll make rational decisions and how they interpret the information, but that disclosure is not always obvious.

Antoinette Schoar: Exactly. I think one thing that people – I mean, I know it sounds so boring and it sounds like a boring economist, but when you are shopping for any type of financial advice, but also maybe other advice, you have to expect that the person has to be paid. Most people don't work for pro bono and for the kindness of their heart. I know, that's why I'm saying, it sounds like the horrible economist who always says that everything has to be compensated, but we all want to live and probably, want to live well. So, why would advisors who have good knowledge should they give it for free? I'm just saying that therefore, customers should always think, the service has to be somehow compensated. If somebody tells me it's for free, that just cannot be true. I need to dig deeper and understand where are they getting paid.

Ben Felix: Got to follow the money.

Antoinette Schoar: Indeed.

Ben Felix: Based on the research that you've done on financial advisors, what do you think consumers should be looking for when they seek out financial advice?

Antoinette Schoar: I would say, number one, as we just discussed, they should really understand how is the advisor compensated? What is the alignment of incentive, or the conflict? Typically, it's actually great if your advisor is paid by asset under management, because then when your portfolio does well, they do better. The more they grow your portfolio, yes, they also get more fees, but in proportion with the gains that the portfolio makes. In addition, I would say, people should think about getting financial advisors whose fiduciary responsibilities are aligned with them.

Of course, in different countries, I'm sorry, I don't know in Canada what the regulatory landscape is, but in different countries that means different things. There are consumer advocacy groups, and in the US, for example, there's also Consumer Financial Protection Bureau and others where you can get good information about what are the type of compensation schemes that are available and what are the types of, in a way, supervisory frameworks for financial advisors.

Ben Felix: It is similar in Canada.

Antoinette Schoar: It's similar in Canada?

Ben Felix: Different words and different regulations, but overall, a very similar setup, where there are brokers who are not required to act in the best interest of consumers, and then there are specific registration categories where they are required to be fiduciaries. That's great.

I want to move on to cryptocurrencies, which we spoke with your co-author on some of your research on this, Igor Makarov, a while ago. You started looking at crypto, I mean, pretty early in terms of academics who were taking it seriously. What got you interested in studying cryptocurrencies?

Antoinette Schoar: To be honest, actually, my students. What happened is that I've been working in consumer finance and in FinTech and financial innovation and venture capital for a long time, and I somehow thought, “Oh, this crypto thing seems like this niche.” This was, say, in 2012-13. It was to me, initially, very niche, and I thought, I wasn't sure where it would be going. To be honest, I was relatively ignorant, but it actually was. I was happy in some sense to be ignorant, because then, you think that, okay, I don't need to spend so much effort thinking about it.

Then actually, several of my students came to me and basically said, “Look, it's really pathetic that we are MIT, and we don't have a class on the latest things in FinTech and in particular, cryptocurrencies.” Then I thought, actually, they're right. At the time, I was group head actually, at MIT of the finance department, or the department head. I tried to convince some of my colleagues to teach this class, and they said, no. I thought, “Shoot. Now I have to.” This is my conflict of interest.

Then I thought, okay, if I need to teach it, I need to really know it, and I need to understand what it is. That's when I basically started learning much more about crypto. I also in this class, for example, I invited a bunch of people who at the time, were really industry leaders in crypto. For example, the founder of Circle, Allaire. At the time, Circle wasn't even a stablecoin yet. They were just basically an OTC broker, and we had really good discussions. Also, at that time, there was very little formalized knowledge of what crypto was.

It was to me, as a financial economist, I suddenly realized, “Wow. This is actually a very cool space, in the sense that intellectually, there's a lot going on. In a way, there's also some reinvention of finance in that space of people who are engineers and don't know so much finance.” Then when you are a financial economist, you think, “I have seen this movie, and I'm really scared. I see it crashing, and I can tell all these people that it will crash. Of course, they will not believe me.” Then you don't want to say, “I told you so.” But sadly, some of this actually did happen.

Ben Felix: I've seen a joke about that somewhere, about how crypto speed ran all of the lessons from financial economics of the last, whatever, hundred years or something.

Antoinette Schoar: Exactly.

Ben Felix: Based on the research that you've done, and I guess, the interactions you've had in that space as well, do you think that cryptocurrencies have been an overall positive innovation?

Antoinette Schoar: I know. This is a very loaded question. I would say, they're on net. I still feel that cryptocurrencies are still looking for their really big hit application. I wouldn't say the same thing about blockchain. I feel blockchain as a technology for settlement of trade, maybe for even settling of international trade contracts and these type of things has already had and will probably have lots of useful applications. But cryptocurrency as a payment mechanism and as a currency, I feel, indeed, per se, haven't had a huge breakthrough application yet.

However, I do want to say the following. I feel that the fact that there has been so much talk about our payment system, about the inefficiencies of our payment system, about the pathetic fact that until recently, it took three days for a payment from a US bank to another US bank to settle, this is just unacceptable in the 21st century. I'm saying all this to say that, I think, one, at least in the US, very big positive thing that maybe inadvertently came, or maybe intentionally, but came from the crypto discussion is that the US has invested in many new payment brands and trails and many financial service companies, including the credit card companies and PayPal and Visa and blah, blah, blah, are now starting to think much more how to increase the efficiency, the speed, reduce the prices, and so on. I think that on net is very good that this has happened.

Now, in a way, it's very sad that it took crypto for this to happen. I mean, it's just, come on, the technology was there before crypto, but maybe the regulatory appetite wasn't there, the urgency wasn't there. I do actually give, in a way, the crypto discussions, a lot of credit for making people much more aware of the inefficiencies of this.

Ben Felix: It created some competition for existing payment rails, and even if crypto wasn't ultimately the answer, just the notion of potential competition made existing payment rails get more efficient.

Antoinette Schoar: I think it also made a lot of consumers suddenly much more aware of what they were paying and not wanting to take it.

Cameron Passmore: How does a trading behaviour of retail investors and crypto differ from their trading and other asset classes?

Antoinette Schoar: I would say, there's a lot of interesting research that has started to look at the trading of people in crypto. Of course, there were people who very early traded in crypto currencies and there were also big hedge funds and so on that initially did made a lot of money through arbitrage trading. At that time, there was still really big arbitrage opportunity. This is now ancient history, but they used to be this what was called the Kimchi premium. The same Bitcoin token was available to buy in South Korea, let's say, for $2,000 more than on US exchanges, or on UK exchanges. Then, of course, especially institutional investors and hedge funds started to arbitrage these price distortions away. Actually, some early retail investors did really well in these things, too.

Now, I think what over time VC has started happening is that as crypto trading has become, in a way, much more broadly available, there are now many more people in a way who trade on it, I would say, more for the sake of risk taking than really doing any arbitrage anymore. There would, at least our research suggests is that in crypto, the average retail investor actually is much more of a buy and hold momentum trader, while in other asset classes, say equity, or commodities, they are trying to be contrarian.

The last thing I said has been shown not just by us, by actually lots of people who have used data from Robinhood, Charles Schwab, other, basically, discount brokers. What you over and over see is that in the more traditional asset classes, retail investors try to be contrarian. Basically, what does this mean? That means when the price of an asset has gone up a lot, that's when they typically sell. When it goes down a lot, they buy in. They must have somehow a belief that the market overshoots all the time and they know better. That's why they want to be contrarian.

In fact, there's very nice research by Enrichetta Ravina and her co-authors at HBS that shows that this type of contrarian trading in stock is in particular around earnings announcements. When there is positive earnings announcements, the price goes up, retail investors then want to trade against it. Now, what we see that those same people who trade this way in their equity and commodities in crypto, they don't do this. When the price goes up, they keep holding, and they don't sell. When the price goes down, they also actually hold and they don't either necessarily buy a lot more, but they also don't sell. People seem to be much more willing to, in a way, endure the market movements in their crypto trading than in anything else.

Ben Felix: What do you think explains it?

Antoinette Schoar: Obviously, we can't. We just see people's trades. We don't look into their brains. We also didn't have a possibility to survey these retail investors. There is work by, for example, people at Berkeley that have surveyed investors, too. We think a lot of it is that the return expectations that people have in cryptocurrencies is different from other asset classes. What I mean with this is that people somehow have this belief that in cryptocurrencies, when the price goes up, they think it's an indication that the price will keep on going up.

Some of it is because maybe they have behavioural biases and they think, oh, the price can only go up. It's not all irrational, because if you think about, especially in the early days, I mean, we are still in the early days of crypto, because we all don't have a lot of cash flow information, cryptocurrencies don't yet generate a lot of cash flows, so what do you have? You have only the price to update about the future adoption of cryptocurrencies. What we think is going on is that what people basically want to figure out is, will crypto become really big?

It's already growing, but will it become really big? What model to put on this is very complex. When they see the price going up, they say, “Hmm, it means that more people are adopting crypto, more people are trading in it. Maybe it also means that regulators will look more favourable on it, that it's not going to collapse. Yes, if that's true, then there will be more positive network externalities and the price will keep going up.” Therefore, I think it's actually not irrational if people think that when you see an increase in the price of crypto, it might also mean that it's there to stay and therefore, the price should be going up a bit.

Ben Felix: It's super interesting, just the behaviour of people trading in stocks and crypto is different. That alone is just fascinating. You mentioned earlier, being able to bring your financial economist perspective to crypto and see things before they collapse, and you wrote a paper about the Terra Luna collapse. Can you talk about what caused that?

Antoinette Schoar: What caused that. What our research suggests is basically, that this was a system that was becoming less and less sustainable. We can go into the details why it wasn't sustainable. Basically, there was anchor protocol, which is something that was basically, like the money market fund for crypto that was paying out more than 20% in its deposit rate to the people who were depositing funds on this defi app, but they were not generating 20% on the tokens, basically, on the stablecoin USD.

Then, what our research suggests is that over time, a large fraction of the participants in that system started realizing, this is not sustainable, and actually, that this high deposit rate was being subsidized by some of the investors, the early investors in Terra Luna, and also the insiders who had made a lot of money from the hype in Terra Luna and the fact that the Luna price had gone up so much. Then, what we show looking at blockchain data from the Terra Luna blockchain is what seems to have been the case is that there was a trickle of people starting to leave Terra and also sell USD the stablecoin that the system had.

Then what happened is that a few large investors decided to take their money off the table, so to speak. Then there was a run. But I want to be very careful, because early on, the run of Terra Luna, the co-founders of Terra said that, “Oh, this was a malicious attack by some outsiders, who were trying to destabilize the system, almost like a bank run.” If you run on a bank that has money invested in illiquid assets that might even be very valuable. But if you force them to do a fire sale, then a bank can feel that is even a solvent bank. This is why banking is so difficult. That's why we have the fed, and so much regulation of the banking system, and so on.

What our research shows is that that doesn't seem to have been the case of Terra Luna. The problem of Terra Luna was basically that there was no seriously productive asset that they were investing in. With time, more and more people realized, wow, this has to come to an end. Then it was more a question of who will let the first shoe drop in a way, rather than this being a malicious attack. Then, what we basically show in the research is that ultimately, it was large investors that ran first, realizing how this thing really is going down. Unfortunately, the small and poorer investors were the ones who didn't realize that even a run was already starting, so they kept buying. In fact, they even kept buying from the big guys who were running from the system and they only ran much later when the price had already collapsed quite a bit, and so they lost way more money.

Ben Felix: Big informational asymmetries that affected the smaller depositors.

Antoinette Schoar: Exactly. The same thing is, of course, that one of the promises of the open permissionless blockchain initially was that everyone, even small people can see what's going on on the system. Exactly as you just said, Ben, just having the data is not knowledge. You have to have the model to understand what is going on. Is it a run? Is it not a run? In fact, I saw on many crypto Twitter and the chat rooms of Luna and Anchor, during the run on Terra Luna, some people were saying, “Oh, now is the time to buy the dip.” You see, they didn't even understand this was a run. They thought, oh, now is a good time to buy into it. That really shows you that they really didn't understand the underlying system that was being created.

Ben Felix: Crazy. You'd have to think also that with a project like that, the depositor base would be relatively undiversified just by nature of it being a crypto project, which is banking risk management 101 did not have a concentrated depositor base.

Antoinette Schoar: Absolutely. In particular, I think in Asia, in particular in South Korea, a lot of people lost a lot of money. Because the founders originally are from South Korea, they marketed it more strongly there. From everything, what we said, they are actually, the welfare impact on many retail investors really was very horrible.

Ben Felix: That's terrible. What do you think the outcome of this thing suggests about the role of regulation and maybe even central banks in the financial system?

Antoinette Schoar: In the end, there is unfortunately, you can say, but unfortunately, financial markets will always have risk. In particular, banking has a lot of risk, because they are, as we were just saying before, banks inherently, if they do maturity transformation, meaning they invest in long assets, but give you deposits that you can withdraw whenever you want, they are inherently somewhat fragile. That's why we have a regulatory system, like the central banks, a lender of last resort, a deposit insurance, like the FDIC to assure people that they don't need to run when they hear a crazy rumour, if it is a regulated bank.

In a way, there is a reason why all these things are in place. They do protect in particular retail investors. I mean, if you think about it, people don't have time to watch their money 24/7. They have real lives to live, they have work, where they have a schedule. You have to be very wealthy to just be looking at your money, to be very honest. I think, what we have basically seen in crypto is that ultimately, all these truths that people have been studied in a way, these repeated things that occur in financial markets also occur in crypto. Just the fact that something is on a blockchain, or that it's outside the regulatory framework actually doesn't make it somehow better. It does not even make it more competitive. That's I think the shocking thing that many people don't understand.

I hear this all the time from people who are in crypto that they say, “But look, the one big difference is because it's an open system, it's a permissionless system, anyone can access it. Therefore, it is more competitive.” But that's not true. The reason it's not true is because financial services by their nature have massive economies of scale and score and they have network externalities. What does this mean? What it means is that when you big begets more big in finance, liquidity, if you think about it, is the ultimate network externality. It's basically, when you are a big market, even if you charge people a lot, traders will come to you, because execution is best in the liquid market.

That's why if you look even in the crypto world, UniSwap is still the biggest decentralized exchange, even though there have been many startups like SushiSwap and many others. But you can see that without any regulatory intervention, naturally, that system actually became very centralized and it's exactly because of, in a way, the natural law of finance that economies of scale, or size are working.

Think about the following, when there is no regulation possible, once a provider becomes very big, nobody is telling UniSwap, “Look, your fees should not exceed XYZ. In particular, it shouldn't exceed XYZ for really small people, who don't really know what they're doing.” Then actually, what you thought, you were exactly saying this before, really in massive fast forward, how a system that was meant to be competitive itself made itself very uncompetitive. We see this in many of these financial applications in the crypto world.

Ben Felix: It happens in finance, it also happens in technology where decentralized technologies tend to centralize, and crypto is getting that from both sides, from the technology side and the finance side. Another area that you've done a ton of incredible research is private equity and venture capital. For retail investors, what do you think about private equity and venture capital as an asset class?

Antoinette Schoar: I think that for most retail investors, it's not a great idea to invest in private equity and venture capital. The reason is that from a lot of work that has been done over the last 20 years and I have some very old work with Steve Kaplan that we did. What, basically, we see is that in venture capital and private equity, you see massive differences in the performance of funds way, more than in mutual funds or any other traded asset classes. It really matters with whom you invest. It's not just, oh, I can build a diversified portfolio, because the stakes are so big. If you are a small investor, there is no way you can be diversified. You need easily, 500 million dollars to be even close to diversified across some private equity funds. If you really want to be in private equity, ventures, the funds are a little bit smaller. In private equity, you need even more. A retail investor cannot achieve.

Now, on top of it, actually, in some more recent work that I've done with Josh Lerner, what we also saw is actually, who you are matters in private equity. This actually goes back even to the discussion we had about financial advisors, which is basically, the best private equity and venture capital firms will charge clients based on how valuable they are to the fund. What we have basically seen over the last decade in particular is that if you are a really big pension fund, or the endowment of Gail and MIT and Harvard and so and so, you basically have a lot of money and you have some expertise and you have maybe a name brand, you get into much better funds than if you are an average person.

Then we have shown that if you don't get into the best funds, actually, the performance is worse than just investing in the index. That's why, I think, for retail investors, left to their own effect, so just in their 401k, I don't think that's a good idea.

Ben Felix: That's right. Your stuff on private equity is obviously incredible research. You mentioned pension funds. What if we took an ultra-high net worth individual investor with a big name, maybe? Does that apply to them, too?

Antoinette Schoar: There, what we see is basically, it really matters how smart the investor is. There are some very high net worth individual who have a fantastic team that works with them and they make fantastic decisions and have great returns, and then others who, maybe they don't know how to choose their own advisors, or they just got unlucky, but we see a lot of differences. We even see on the pension funds and on the endowments, I was just saying endowments, but the smaller endowments who don't have the money to invest in an expensive staff that can really understand private equity and venture capital well enough, they typically have bad returns in VCP, while the pension funds and endowments that are large enough and have over time invested in a good enough staff, they are the ones who have better returns.

One thing that I worry a lot, and sorry, you didn't ask this, but this is something that really keeps me up and that is that you see, the nature of private equity and venture capital and the fact that it's so illiquid means that you can hide bad returns for quite a long time. If for eight years, or maybe even 10 years, there is no reckoning and then there are bad returns. Now, why is this particularly bad for pension funds, but also for endowments is because if you think about a university, spends out of its endowment based on a rule on the endowment returns. Now, if it's a publicly traded return, if your portfolio did poorly, well, then you don't spend so much.

But in VCPE where you can pretend that, oh, we have 12% return for 10 years and therefore, the university might overspend out of its endowment, basically, what you're doing is you're beggaring future generations in order to spend today. Now, if today's research is brilliant and people do a great job, well, maybe this one’s good. But if they don't, then I think people need to understand that we are actually de facto stealing from future generation, or from the young people today by pretending that we have these great returns. The same is true for pension funds. It's basically, we are giving today's pensioners way more and we're taking from the young. I'm an old lady. I'm not on pension yet, but really, it worries me that the more we do this, the more we're leaving the young generation to hold back.

Ben Felix: Holding them back, I agree with you. On private market valuations, we don't touch it as a firm, so it doesn't keep me up personally per se, but I think it's pretty scary. There's an article recently in the Wall Street Journal about private market valuations and how funds acquire private assets for a steep discount to their mark, but then value them in the fund at the mark and it looks like, they just got a really big positive return, which then affects the fund's performance, which then affects investors allocating to the fund. Of course, you can't argue that's a real valuation, I don't think. I agree. That's very scary stuff.

Antoinette Schoar: This is exactly again, where because the liquidity allows you to hide a lot, if people don't fully understand these implications, they are not aware that this is happening.

Cameron Passmore: Our final question for you, Antoinette, how do you define success in your life?

Antoinette Schoar: I would say, in my professional life, I hope to prove the research that I do to inform people, so that they make better decisions for their life and that we improve how markets function, how finance functions, so that financial services really serve people, rather than basically, adjust the way to extract rents from helpless retail investors and people in general. In life, I think it's more complex. You hope to be a good person to the people that you are around and have a positive impact on them, and that means very important, but it's an ongoing struggle, I think, for the rest of one's life.

Ben Felix: Great answer to the question. All right, Antoinette, that's our last question. This has been a great conversation. We really appreciate you coming to the podcast.

Antoinette Schoar: Thank you very much for having me. It's been lots of fun to talk to you.

Cameron Passmore: Such a great conversation. Thanks, Antoinette.

Antoinette Schoar: Thank you. Take care.

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