Cancer Research conducted a survey a couple of years ago which found that 90% of people who are clinically obese don’t think they have a weight problem. To be honest, I wasn’t particularly surprised. Thankfully I’m still safely inside the “marginally overweight” category, but I know full well that when I am carrying too many pounds I’m the last one to admit it. I only tend to take notice when a close family member points it out; and thankfully my teenage children are only too happy to oblige.
I wonder, then, whether the recent comment by the chief executive of the New York-based asset manager AllianceBernstein that the fund industry has grown too large will finally spur the sector, and its regulators, into taking remedial action?
Peter Kraus told the Financial Times that his industry has a “scale problem”. Asset management, he said, is in “secular decline because it has overcapacity”. At a certain point of size for a mutual fund, he explained, “the incentives shift from trying to outperform your benchmark to not wanting to underperform. Our advice to the industry is to constrain ourselves. We are hurting ourselves by growing too big.”
But the fact that many funds are too large is, for Mr Kraus, just part of the problem. There are also far too many of them. The number of US mutual funds, he said, has more than doubled over the past two decades to more than 9,000 but “intuitively the number of talented managers hasn’t doubled”.
“If there are no capacity constraints the returns would be constant with assets under management, but we know that’s not true. You end up buying more stocks with low conviction,” he said.
This is a rare example of honest self-analysis by the asset management industry. Over the years we’ve heard all manner of excuses as to why the vast majority of active managers fail to do what they’re paid to do — namely, to beat the index for meaningful periods of time — but at last a senior figure in the fund world has come out and admitted that the problem is more fundamental.
That the fund industry has grown too big seems to me to be so blindingly obvious that I’m amazed it hasn’t been said more often before. I’ve said it for years — and Charley Ellis for far longer than I have. Charley is an investment author whose book, Winning the Loser’s Game, was instrumental in prompting people to start questioning the value of active management in the mid-1970s. In an interview for TEBI last summer, he said this:
When I came out of business school in the early 1960s, there was one course on investment administration at Harvard Business School. There were no courses on investment management. Only two of us went into the investment management world. The next year there were three or four. By the time a decade had gone by, there were 50 or 100 coming in every single year. There has been a flood of extraordinarily ambitious, talented, well-educated, knowledgeable people coming into investment management. Those individuals, now a couple of hundred thousand of them, all over the world, are all competing, all trying to figure what the price of every single security ought to be, and they’ve done a very good job of it. The chance of doing better than all the others is getting less and less and less, but the fee has stayed high, so that incremental fee is hard pressed to earn its way with the incremental return.
It’s easy to see how asset management has ballooned. It is, after all, hugely lucrative, not just for fund houses but for all the different intermediaries involved. People are instinctively very receptive to the idea that there are expert managers out there, easily identifiable, who can consistently beat the market. There’s also a whole branch of the PR industry dedicated to perpetuating the idea that active managers are money-making rock stars.
Alas, the evidence clearly shows that the vast majority of us are better off taking Warren Buffett’s advice and ignoring active money management altogether. Yes, we need active managers to set prices. But we need far fewer of them, earning much smaller salaries and providing far more value for money than they do at the moment.
For me, the blogger Jesse Livermore summed it up the other day when he said this:
“Active management is not going to completely die off — it’s just going to keep shrinking, until the right balance is reached. That balance, in my view, is still a long ways away.
“At its current size and cost, the active segment is not even remotely close to earning its fees … [A]s a group, they are simply too large, and too costly, to be able to earn those fees consistently.”
No more excuses, no more denying this is a serious issue. Let the diet commence.
Image: Tony Alter