I'm a sr equity analyst at a large AM w/ >10 yrs of experience with a potential path to PM someday... basically mid-career. I've managed my career path really well, but find myself looking at the future of AM wondering how much opportunity there will be for fundamental discretionary equity investors. I'm really hoping for some thoughts, particularly from those already in the industry.
From what I can see the AM industry (particularly US/Europe large cap) has been under tremendous pressure... AUM keeps moving into passive products and fee pressure grows year by year. One could even argue that the only reason the industry hasn't had a huge shakeout is because we've had an unprecedented historically long bull market relieving the pressure of the exiting AUM.
So, where do things go from here? Here's my guess...
Institutional Assets - fees will continue to compress w/ large institutions paying 45/35/25bps, maybe going all the way to 15bps. Large AM firms will have a complete range of products, all geographies, all style boxes, all asset classes, all styles... even esoteric things like thematic and ESG, etc etc. They'll trade lower fees for higher share of wallet. Rock star PM's will be a thing of the past. They'll be replaced by multi-PM/analyst teams so that no individual person becomes too important to the product. So, comp will come down. $1m+ paydays even for PM's will become increasingly rare. Firms will leverage large pools of central research, where the analysts are nameless. It'll be a fixed cost that can be leveraged. Comp there will come down too. The power will shift away from the investment staff... owning the sales relationship will increase in value. It's hard to envision a scenario where comp does anything but trickle lower for the investment side.
HNW Assets - the double layers of fees will (and probably should) eventually go away... why pay for advice (from your HNW advisor) and a fee for a fund... it'll be bundled / vertically integrated is my guess. You pay 1% for the advice and get free or nearly-free access to that firm's funds. Like above, the role of the people choosing the equities/credit to invest in goes down and the role of the people who own the relationships stays strong/continues to grow.
Large, full-scale AM firms will try to build out both sides of the business. Institutional has big pools of capital and HNW is higher fee and very sticky AUM.
On both sides, the value of stockpicking is becoming commoditized and the investment management function will be viewed as a fixed cost that needs to get leveraged. Firms will have a large swath of funds and if one underperforms the relationship owner will shift assets out of the underperforming fund into another fund at the firm. There'll be so many funds there'll always be something outperforming.
Career Path...
As a long-term investor, I spend a lot of time thinking about where a business is going to be in 5-10 years and how the business model is going to evolve. When I look at AM through that lens, it's not particularly encouraging. It's an industry going through disruption and a long tail event like a bad bear market could really escalate a huge thinning of the herd.
So, when I think about this relative to my career it's a really hard decision... I'm on a great path in AM, w/ potential to get to PM someday... but if I leave now I could get a jumpstart on a great career path outside of AM in a business that's under less secular pressure. I have two friends in my age/experience cohort who left AM years ago and are CFO's now. So, it's tempting to flirt with the idea of leaving proactively.
Different view?
Does anyone have a different view? Am I too cynical? Is anyone bullish on the long-term outlook for AM??? What am I missing?
I had been pretty bearish on the industry the last couple of years. Maybe it’s a function of where I sit (smaller cap with value tilt), but I think this year has shown that active managers still deserve a piece of the asset allocation pie. For example, the 50th percentile fund in the small blend Morningstar category is outperforming the r2k by over 350 bps ytd. The press loves to print stories when how active managers are getting beat by etfs but it is oddly quite when the opposite is true. Obviously this is just one short term data point, but just like anything the market works in cycles. The past decade was allocators riding the wave of passive dominance. Maybe we are beginning to see signs that it was overdone and etfs blindly buying large stakes in companies will create more opportunity for active managers to generate alpha.
I’m bias and might to stating the obvious, but it feels like there is much more opportunity to add value with smaller companies as compared to large and mega caps.
On leaving the industry, I think that is more of a personal ambition question. Personally, I feel making a couple hundred k a year picking a few stocks a year would be a lot less stressful than being a CFO. It’s not like the job will ever be mind numbingly boring, so if you can hang on to the seat and maybe be a co pm one day sounds like a pretty good gig to be.
Wait for the bear market to come, and watch how the view toward active management changes drastically.
Fund raising is the most backward looking activity in the history of mankind.
I am sticking to this view.
These “is AM dying?” posts literally show up weekly, but for whatever reason they always tempt me to respond. If I was a rational optimizer, I really should just promote that negative view on the industry. The last thing I need is more competition in the markets in terms of my own personal career. On the other hand, WSO content has been valuable to me, so I feel a slight obligation to contribute content that will help others.
On Passive: There is a passive active equilibrium at some level of assets between the two. It is true that most investors are better off going passive, but it is also true that passive quite literally depends on active to function properly. Active performs price discovery based on fundamentals and ensures that there is some kind of economic relationship between market prices and the actual underlying businesses. In a world where all money is passively invested, companies would have unlimited access to equity capital, as dilution would never be punished as long as investors maintained some kind of allocation to equities as an asset class. I personally do not think this is realistic, but following my earlier logic, if the majority of investors would be better off going passive, could the majority of invested assets be allocated to passive funds? Yes. But the term majority is admittedly nondescript and I don’t know what the right split is, I don’t think anyone does yet and flows to passive could continue.
The Paradox of Passive Investing and Efficient Markets: One reason that passive investing is popular, is because a lot of investors and academics believe that the markets are efficient. But let’s think about that for a moment. What is the premise of the efficient markets hypothesis? Market prices should reflect all available information and that investors should be rational optimizers. What is the quality of the information content that is being incorporated into market prices when a passive fund buys a basket of stocks? Passive needs active to function properly.
Additionally, are investors rational optimizers? Even as a professional investor who is aware of all the potential biases I could fall victim to and constantly on the lookout for bias in my thought process, I admittedly am not a perfectly rational optimizer. I have emotions and investing can be emotional. Is it possible that investors sometimes buy/hold/sell securities for reasons that deviate from their rational assessment of all available information?
I think it’s funny that a lot of people will support EMH but have never actually read the arguments. It’s interesting to go back through time and look at this strange academic war between Fama/French and the EMH crowd and guys like Thaler/Kahneman and the behavioral crowd. Fama admits that the model is imperfect, but his primary defense against the behavioral arguments is ‘well you haven’t come up with something better that describes the market more completely than EMH so EMH is still the best model we have’. Here is the actual quote “Most important, the behavioral literature has not put forth a full blown model for prices and returns that can be tested and potentially rejected—the acid test for any model proposed as a replacement for another model.” Only in economics do you hear an argument like ‘it might be wrong, but you don’t have anything better’ as if that somehow validates the original argument. The best model of the planet earth used to be that it was flat, but just because there was not a better model did not make the flat earth model intrinsically correct.
I actually find the concept of completely efficient markets to be illogical because it requires you to assume things that cannot possibly coexist, but I do think that EMH as a framework is valuable to an active investor. Rather than turn this into an EMH argument, I will simply say that I do not believe markets are efficient, and that it is a complete paradox that passive investing is built upon this belief yet dependent on active investors to make it work (who are presumably acting irrationally for believing they can beat the market). Passive flows make the market less efficient because they result in transactions that are not based upon the rational incorporation of information into security prices. So again, there must be an equilibrium. Could the majority of assets be allocated passively? Sure, but it will never be at the complete expense of active investing.
Again, don’t want to turn this into an EMH Chicago school of economics debate, but I highly encourage you to actually read the academic papers and arguments for and against market efficiency for yourself and form an original opinion rather than simply taking my opinion at face. I think you really need to form some type of view on this debate as a precursor to evaluating the future of active management. Fama is probably the most well-published EMH author and has produced multiple papers on the subject over the years. French and Malkiel are also supporters. On the behavioral side, Thaler, Kahneman, Treynor, Fischer Black (see: Noise), Bradford Cornell (see: what is the alternative to market efficiency) all have put out good papers over the years as well. Actually READ the original arguments and decide for yourself, then evaluate the future of the industry from that context.
But what about the performance? The industry as a whole underperforms so that must mean that markets are efficient? This is certainly an argument that the EMH crowd uses, but again, I don’t believe that the lack of a substantial number of strong performance records necessarily validates that markets are efficient. Rather, I think the correct conclusion is that 1.) It is just really difficult to outperform, and 2.) The industry is more incentivized to focus on asset gathering rather than outperformance.
Taking the first part of that, it is just really, really difficult to outperform, but there are funds that do it. Everyone is human has emotions, and emotions are the enemy of investment performance. As I have become more seasoned, I have come to believe that emotional discipline is the single largest differentiator in outcomes between different managers, and it takes a lot of effort to even identify who has it and who doesn’t. Along those same lines, another commonality amongst firms that outperform is that they are willing to say ‘no’ to moving beyond a reasonably manageable capacity. Funds with true discipline and performance-oriented cultures will shut the doors once they get to a certain size in order to remain agile. These types of funds also tend to have one singular house view as to an optimal strategy or investment philosophy. So these firms are not going to be able to run $100B in assets, because 1.) They will close the doors to manage capacity, and 2.) Their capacity will naturally be more limited by their house view and lack of multiple divergent strategies marketed/offered to investors.
Taking the second part of that, the industry as a whole is incentivized to skew towards asset aggregation rather than performance. As others have mentioned, AM has tremendous operating leverage as it is currently structured. If a $1M client gives a fund an incremental $10M in assets, the fund manager’s expenses do not rise an incremental $10M – they may not rise at all; however, FEES rise DOLLAR for DOLLAR with assets, and hence, the incremental fees almost completely drop to the bottom line. So for a fund manager, it is much easier and more profitable to acquire an incremental $10M in assets from that client than it would be to increase that client’s account organically (which would require 10x returns). Thus, the incentive is completely skewed towards asset aggregation rather than client outcomes and performance. So what is the best way to increase AUM? Throw a bunch of strategies and fund managers at the wall, see who sticks, then market the hell out of the ones who work and ride those strategies to asset growth. It makes really no difference whether or not the performance is repeatable or not, because allocators tend to give managers who have performed well in the past initial preference in manager selection, and long leashes to right the ship if performance turns; all the while the firm running the fund will be continuing to eat those juicy management fees. This is precisely what you see at virtually all of the largest asset managers in the industry. As these funds grow assets and expend marketing dollars, they become the face of the industry, and as you would expect, their performance track records are usually unremarkable. Part of this is also to blame on the asset aggregators, who make this inertia possible by focusing more on meaningless metrics like tracking error, past returns without context or evaluation of strategy, and artificial segmentations of the investment universe like value/growth/large cap/small cap. In other words, the industry as a whole is fucked and everyone is to blame, but there are some funds out there that have genuine discipline and genuinely repeatable performance track records, just don’t expect to find or hear about them without some work on your part.
On Alternatives: There is no free lunch and it is a bit of a myth that you can get higher returns with less volatility in alts. Yes returns have been higher on an absolute basis, but that is more of a function of illiquidity, the aggressive use of leverage, lack of mark-to-market volatility, and performance lockups. If you adjust for these factors, as some have attempted to do in academic literature, you end up with returns that are undifferentiated from vanilla public equity. Not many allocators really care though because their bonus plans do not make such adjustments, but I believe that this will come to the forefront over time, especially if the rate environment ever becomes less accommodative. The single biggest advantage that alts has is the lockups features and illiquidity. I say illiquidity not because of the premium that you should theoretically get for assuming that as a risk factor, but because the illiquidity protects you from yourself; you can’t panic sell your alts allocation and the funds themselves can’t panic sell their equity investments. In other words, it forces low turnover and a buy and hold mentality, both of which have been documented in the literature as historically leading to better results in public equities.
TLDR: Yes I am bullish on asset management if you are at a fund that is structured for performance outcomes rather than asset aggregation. Take a look around, if your shop is offering 100 different niche strategies and segmentations, and average fund/fund manager tenure is fairly low, you’re probably in trouble. I think that all of the pressure will be on these types of funds despite their scale economics and ability to reduce fees as an offset. There will always be a premium for outperformance, and there are funds that have repeatable processes and strong long-term track records, as rare as they might be. Passive has limits, and the growth of passive by definition necessarily makes the markets less efficient. I think the future of the industry can be improved by sharing of the scale economics through more aggressive breakpoints in fees. I think that is a secular pressure on the industry and revenues, but performance justifies fees, and I don’t see genuinely strong performers as having the same types of pressure.
This was an exceptionally intelligent, insightful, and well-written post. Kudos
Thanks for the thoughtful response. Agree with you on passive, there are some places in equities where it really doesn't work and the tracking error can be very high (like 200-300bps), particularly in smaller caps and emerging markets.
EMH is a garbage and anyone who has invested other people's money professionally for more than a year will attest to that. And I would argue that the market has become increasingly inefficient over the past ~5 years as passive mix has grown. Markets seem to trend and moves tend to go too far and then rapidly correct. I agree we don't know where the limit is for US large cap passive mix, but I suspect it'll overshoot before we find out.
Large sophisticated institutional investors are not going passive. They will always be active. But they are pushing fees lower every year and that has an impact on the future of the industry.
I think the crux of your argument is that active management will always have a role, and I agree with that broadly, but what has changed is that beta is now free. A large institution can go to go Fidelity or GS or BAML and get the S&P 500 for free, then they can go to Citadel or Point 72 and get something like +400bps of pure alpha after fees and combine the two and instantly beat the market. You could also probably argue that the increasing inefficiency of the market is creating more opportunity for L/S. So, active management can still grow, but it's getting harder on the LO side. I agree with your logic that the most of the shrinking will come from the closet indexers who were really just asset gatherers... owning 125 stocks out of the S&P 500 isn't something anyone should be paying 100 bps for.
Alts - I don't know if you've read/listened to any of Dan Rasmussen's stuff arguing that we are at peak PE and PE is basically where HF's were in 2005-07 when they were the rage. This YouTube video was really good... here he attacks multiple asset classes... very entertaining...
Really long post (and decent read) but I think you’re missing a key point here and this is Fama’s point: it’s not about the fact that some funds do outperform (which you mention), it’s about the fact that as an industry, the percentage of funds that outperform is not significantly different than chance (think Warren Buffett coin flip analogy). Fama would agree with you that some funds outperform, but that isn’t the point. The point is that after accounting for fees, it is impossible for an allocator to choose which fund will outperform going forward.
Sure, investors act on emotions (we saw this during Gamestop recently), but again, over the long term, regardless of these emotional blips, the percentage of funds that outperform (after fees) is not significantly different than chance. And this is a fact according to any/all research I’ve ever seen, not my opinion.
I also think you’re being disingenuous to Fama’s quote on the model. He’s not saying “the model might be wrong but it’s all we have”, he’s saying “IF the model is wrong, then you have to come up with something better that can be tested - and there isn’t currently a model that does that”.
Thoughts? Genuinely interested in the back and forth...
I am not disagreeing with you that the numbers for the industry in aggregate are not good. I think my point was that the numbers are not good, but that in and of itself does not support that markets are efficient (as opposed to Fama who uses this as a proof point to support the EMH). Rather, the numbers are not good because the funds that do outperform are smaller and not easy to find, the funds that are easiest to find are set up for asset aggregation not performance, and it’s just very difficult to outperform even for well-credentialed industry vets; however, it is possible to outperform.
The question of whether or not markets are efficient is key to the OP’s question of is anyone bullish on the future of asset management. If markets ARE efficient, then really no one should be bullish on the future and any track record of outperformance could be attributable purely to luck. If markets ARE NOT efficient, then there is still reason to be bullish on AM and skill will continue be valued in the marketplace. Have markets become more efficient over time? Yes, absolutely, you used to have to go to the library to look up a PE ratio and now any idiot can get one in about 5 seconds from their brokerage account. But have ‘become more efficient’ is quite different from ‘markets are efficient’ as Fama and his supporters would claim.
I don’t think it is disingenuous in the least to supply that direct quote from Fama. He is quite literally saying that EMH is the best model we have until someone comes up with a better one, there is no other way to read that. ‘IF the model is wrong’ is a dubious distinction because it’s virtually impossible to prove the model right OR wrong. It’s actually brilliant on his part because it can never be definitively proven or disproven, thus it can never be definitively displaced. All of the support Fama has ever provided in favor of EMH is circumstantial at best, as has any of the evidence provided on the behavioral side to be completely fair. Virtually all academic market studies focus on some singular anomaly, or a handful of singular anomalies, from some specific time period, and then the authors extrapolate that as if it applies at all times, across all markets.
Markets are highly dynamic and constantly evolving; there is no simple model that can describe markets in totality. People like to try and simplify things with models, but economics is probably the most egregious example of pseudoscience that I can think of.
Bringing it back to the OP’s question, markets are not efficient and I think there are reasons to be bullish on AM IF you are at a fund that is setup for performance and has discipline and a repeatable process. Fees are going to come down, but funds that perform can justify fees. It’s no different from any other product or service, better performance is valuable and results in pricing power. I think the solution for the industry is a more aggressive sharing in operating leverage. Breakpoints need to be more aggressive as assets scale, effectively kicking back some of the fund economics to investors.