Just How Useless is the Asset-Management Industry? - HBR

http://blogs.hbr.org/fox/2013/05/just-how-useless-is-the-asset-.html

Thoughts on this?

Professors have been basically telling me to put my money in index funds. I think that one of Asset Management's roles is to pretty much make the markets more efficient through the "experts'" advice through allocating capital where it is needed/worth allocating to. Thus, institutional investors are a big part of this. What about the individual investors?

What will happen to management fees then? Will they be shrinking?

 

Well if everyone would invest in index funds, then there would be perfect correlation between assets. So some form of asset management is needed. The problem however is how to find the true alpha generators. I think the market share of active managed funds is currently too high. But active managed funds should always have a significant market share.

 

I had a professor who advocated index funds as well. It still shocks me that a well educated team of analysts who spend countless hours researching and analyzing companies cannot pick stocks that outperform the market.

I wonder how much of this is driven by management fees. If fees were removed, would actively managed funds have outperformed index funds historically? With all of the public information and valuation tools out there, it just doesn't make sense that actively managed funds can't beat the market.

 
Best Response

NO. STOP. Do not listen to this. Why am I not at an asset manager or hedge fund right now? Unflinching belief in academia. Read this: http://www.tilsonfunds.com/superinvestors.html

Mutual funds tend to underperform because there is an enormous incentive to index, then market aggressively. Even if they track the index, they will underperform net of fees. And people tend to underperform the fund itself by buying in at the wrong times.

Looks at the mutual fund managers who actually have some balls. Fairholme, Ruane Cunniff, Harris, Third Avenue, First Pacific, etc... They generate alpha.

As for hedge funds: performance depends on strategy. Global macro has been getting killed the past few years due to central bank actions. Market neutral should not outperform a rising S&P. Even L/S Equity funds have been having issues due to the "new normal" investing environment (which actually makes me wonder about my own investing skills, since 100% of my experience is post crisis).

You also see the "too big to succeed" problem play out in hedge funds. A lot of managers do well investing in small caps, but then are unable to maintain that performance as they become limited to larger companies.

Fund flows usually come after a hot streak, and the manager may or may not be able to deploy that new capital effectively. Paulson is probably the best example of this.

 

portfolio management requires diversification... some asset managers can provide that.

now modern portfolio theory, while questionable, has the basic idea that adding assets that aren't perfectly correlated will improve ur risk adjusted return. this is essentially a "free lunch" becuz if u leverage up/increase exposure so ur risk is back to the original level, ur return is now higher.

but ya investing in huge mutual funds that track the index adds no diversification

 
cauchymonkey:

portfolio management requires diversification... some asset managers can provide that.

now modern portfolio theory, while questionable, has the basic idea that adding assets that aren't perfectly correlated will improve ur risk adjusted return. this is essentially a "free lunch" becuz if u leverage up/increase exposure so ur risk is back to the original level, ur return is now higher.

but ya investing in huge mutual funds that track the index adds no diversification

Yep, and with modern portfolio theory, the benefits of diversification reach zero once a portfolio has 20-30 stocks. Holding any securities above that just brings your return closer to that of the market, and you're left with a return that can't beat index funds after management fees come out.

 
Industry84:
cauchymonkey:

portfolio management requires diversification... some asset managers can provide that.
now modern portfolio theory, while questionable, has the basic idea that adding assets that aren't perfectly correlated will improve ur risk adjusted return. this is essentially a "free lunch" becuz if u leverage up/increase exposure so ur risk is back to the original level, ur return is now higher.
but ya investing in huge mutual funds that track the index adds no diversification

Yep, and with modern portfolio theory, the benefits of diversification reach zero once a portfolio has 20-30 stocks. Holding any securities above that just brings your return closer to that of the market, and you're left with a return that can't beat index funds after management fees come out.

You don't think that adding bonds or commodities or something else would give you any diversification benefits?
 

And another thing to add: alpha generation at any cost is not necessarily what someone hires an asset manager to do. If you're a pension fund, your liabilities have a certain duration and exposure to various scenarios: more important than a return number at the end of the year is knowing that the mismatch between assets and liabilities is managed appropriately. Same for any number of other institutional clients.

Obviously everybody in the markets wants to come out with more money than they put in. But people want that achieved in different contexts and in different ways. To me, good asset managers are market experts who can make that happen, and who get paid for that service as much as for the ultimate return.

And by the same token, I wonder why so many people in the US use mutual funds to track an index. An ETF is probably gonna do it cheaper. And if you're saving up for something (eg retirement), a target date fund sounds like a better idea. But then, I'm not in the States and maybe there's a good reason.

 

Unlike some of the PMs who have posted in this thread I think this article does have some merit. Somewhere between what West Coast Rainmaker said, tax inefficiencies, and just bad players I'm gonna say at least 50% of PMs do not add value. This does NOT mean that it's impossible to beat the markets, but that like anything competitive the majority of players don't know how to make money, especially vs. the top 10% that actually know what they're doing.

I do worry about where the fee structure reaches equilibrium versus passive instruments since it affects what the above posters and myself eat but that's for another day.

If I ever do make it to starting my own shop in this industry I would probably make it a SMID equity or event-driven mutual fund with a soft close at $1B and number of positions capped at like 60.

 

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