more trouble for active managers

When I started in the investment business in the late 1970s, fees of all types were, by today’s standards, almost incomprehensibly high.  Upfront sales charges for mutual funds, for example, were as high as 8.5% of the money placed in them.  And commissions paid even by institutional investors for trades could exceed 1% of the principal.

Competition from discount brokers like Fidelity offering no-load funds addressed the first issue.  The tripling of stocks in the 1980s fixed the second.  Managers reasoned that the brokers they were dealing with were neither providing better information nor handling trades with more finesse in 1989 than in 1980, yet the absolute amount of money paid to them for trading had tripled.  So buy-side institutions stopped paying a percentage and instead put caps on the absolute amount they would pay for a trade or for access to brokerage research.

All the while, however, management fees as a percentage of assets remained untouched.


That appears about to change, however.  The impetus comes from Europe, where fees are unusually high and where active management results have been, as I read them, unusually poor.

The argument is the same one active managers used in the 1980s in the US.  Stock markets have tripled from their 2009 lows and are up by 50% from their 2007 highs.  All this while investors have been getting the same weak relative performance, only now they’re paying 1.5x- 3x what they used to–simply because the markets have risen.

So let’s pay managers a fixed amount for the dubious services they provide rather than rewarding them for the fact that over time GDP has a tendency to rise, taking corporate profits–and thereby markets–with it.

The European proposal to decouple manager pay from asset size comes on the heels of one to force managers to make public the amount of customer money they use to purchase third-party research by allowing higher-than-normal trading commissions.  Most likely, customer outrage will put an end to this widespread practice.

Both changes will doubtless quickly migrate to the US, once they’re adopted elsewhere.




active managers’ assets shrank last year

The Financial Times reported on Halloween the results of a study by Willis Towers Watson done for Pensions and Investments (how’s that for complicated?) showing that the assets under management of the top 500 fund management firms shrank in 2015 for the first time since the Great Recession ended.  The decline was greatest for Europe-based managers.

Several factors appear to be at work:

–sovereign wealth funds, especially those sponsored by Middle Eastern oil exporters, have been cashing out to fund expanding budget deficits

–large traditional pension providers are taking assets away from third-party money managers to handle them in-house (this could turn out to be just as disastrous as do-it-yourself dentistry or knee surgery, if the pension administrators try any form of active management)

–flattish markets and a strong dollar, reduced the d0llar value of non-US assets, resulting in slight investment losses.


In addition, within the industry market share is shifting:

–the top 50 firms increased assets; the other 450 lost enough to more than negate those gains

–assets shifted from high-fee active management to low-fee passive alternatives.


My thoughts:

–not a good time to be a small or mid-sized asset manager, since operating profits are contracting both from lower assets under management and from lower fees on those assets.  This implies to me that greater numbers of minnows will sell out to whales.

–although I can’t see into the inner workings of asset managers any more, my experience is that firms cut their younger, lower-cost (but considerably greater upside) professional employees in order to preserve the income of their higher-paid longer-tenured colleagues.  This is, I think, a recipe for disaster    …and will worsen the position of smaller firms.  More reason to expect consolidation.

–I have little conviction on how this development might affect active management.  My inclination is to think that markets will become less efficient, meaning a better change for you and me to outperform.  Another possibility, though, is that the door will merely open wider for computer-driven investment strategies.  I don’t think this necessarily lessens the chances for you and me.  But it may mean that we will have to key off market indicators that we reckon will have appeal to algorithmic investors, rather than those that will motivate humans.