We’ve got used to thinking of fund managers as the kings of the lot. They are at the top of food chain in terms of pay and the respect offered them by the rest of the financial community.
So the decades long debate about active v passive , has not been a discussion on the value of fund management, but of the type of fund management we employ.
The FT is currently running a piece about the continuing long-term trend towards passive management . As John Ralfe points out, this is not much of a story. But what makes the piece compelling, are the assumptions implicit in the comment of fund managers and their acolytes. According to Amin Rajan of Create, the shift to passive is partly due to
“market distortions caused by quantitative easing programmes of central banks introduced in response to the 2007/08 global financial crisis”.
When Rajan goes on to consider the future, he sees the natural order re-asserting itself.
“Passive investors can suffer full market losses when the market turns, possibly more than active investors who can switch into cash,”
By comparison, the pension scheme managers who responded to Create’s services, prefer to comment anonymously, possibly out of fear of fund managers who they employ! Their comments are very revealing as they fundamentally question the value of fund management.
“There is a one in 20 chance of picking a successful active manager. The chances of picking multiple good ones are minuscule,”
Another funds purchaser points out
“Fees have become the North Star of investing,”
Fund managers are comfortable describing these purchasers as “clients” and talking in abstract terms of the issues of agency, but those who are buying their servicers talk a much simpler language. They talk as customers purchasing a service that is increasingly commoditised.
You can download and read the Create report here
The demystification of fund management
As soon as people can imagine their fund managers sitting on the toilet (my definition of commoditisation), they realise that they are no different from themselves.
I had the pleasure of having a few drinks with a senior funds salesperson the other night. We talked about budgets for client’s conferences. Mine is £6- 12,000, hers is £250,000. She sits on a finer grade of porcelain.
How can fund managers consider spending 20 times more per client than I do? The answer isn’t easy without knocking into awkward questions about incentives. It is extremely hard for fund managers not to spend the money. The ridiculous complicity between the controlling “agent” and the supplicant “master” means that neither is prepared to speak openly about the very obvious elephant, that fees are way too high.
In order for the masters to continue to be entertained, the agents must invent ever more extravagant arguments to demonstrate how impossibly difficult it would be , for the agents to do without them. The result is such bamboozlement that purchasers as powerful as NEST, sign non-disclosure agreements with fund managers, rather than publicise the fees they are paying.
Such NDAs are usually justified on the grounds of “favoured nation status” having been granted the purchaser. This ridiculous phrase suggests to the purchaser that he/she has become a super-buyer, whereas he/she is almost certainly being taken for a ride and is being laughed at back at the fund managers. The only word to describe purchasers who sign up to NDAs on fees is “MUG”.
The demystification of fund management appears to be in nobody’s best interest, least of all consultants – who not only benchmark their outrageous fees against fund managers, but have now started charging fees to clients as if they managed the assets themselves.
The unholy triangle that locks purchasers, advisers and manufacturers into high fees is cemented by mystification of investment management. If the Asset Management Market Review is to achieve its goals, it has to take on the pseudo complexity created by fund managers , reinforced by consultants and accepted by purchasers in exchange for a “free lunch”.
What the move to passive does.
Despite the desperate attempts of organisations such as Create and the Investment Association to prop up active management, it’s quite clear that the game is up.
Customers are clearly less than impressed with the outcomes from paying fund managers to mess about with their money and are much keener on a simple approach that gives them secure and well governed access to capital markets.
Paying for that access is not difficult, working out what it costs isn’t hard and understanding whether the job has been carried out properly, quite easy to do.
What the move to passive does is put the owners of the money back in charge. It takes the mystery out of the fund management process and cuts back the arguments for fund managers to be considered kings of the lot. It trims the budgets for conferences, reduces the arguments for expensive city offices and returns value to the people and organisations paying for their or others retirements.
Fund management is over-rated
Frankly, fund management is a bit of a racket. The best fund managers (like Terry Smith) do very little, the worst are filled with a passionate conviction they can beat the market by adopting complex strategies like GARS.
In the middle is a muddle of managers just getting by, relying on weak purchasers not to call them out. From the look of the FT article, the mugs are in the descendent and pension fund managers are increasingly turning their back on poor value fund managers (and their lackey- consultants).
If this continues to be the case, there is some hope that consumers will get back control of their money and what they pay for it. The value for money debate has only one way to go.
Survey highlights
The Create survey has published these highlights.
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With fees becoming the North Star of investing, passives are reshaping the investment universe (58%)*
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Their rise is a foundational change in the way pension plans now manage their portfolios, blending actives and passives, knowing that both are needed (60%)*
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This broader diversification aims to not only minimise risks but also maximise returns to create an all-weather, buy-and-hold portfolio (51%)*
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Passives are not only becoming a core asset class, but are also being used to access specialist asset classes, secular investment themes and cyclical risk factors (48%)*
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Passives have benefitted significantly from the ultra-loose monetary policies of central banks, which have created epochal challenges for actives to up their game (54%)*
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The unwinding of these policies is expected to have some effect on passives, more likely a slowdown in growth than a sharp reversal in their inflows (42%)*
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Far from being polar extremes, actives and passives are complementary. Each relies on the other to survive and thrive, like yin and yang in Chinese philosophy (60%)*
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Another test for passives will be when they are judged not on their current inflows but on their resilience when the inevitable correction comes (55%)*
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For now, the real debate is not about actives vs. passives but about how to drive out mediocrity in the investment landscape. The rise of passives has kick-started that process (58%)*.
* Cited by percentage of our respondents
DB schemes should be encouraged to use more passive investments. Far too many have active funds plus hedge style funds and pay a fortune for the privilege. Using more passives will cut down costs quite significantly, which is a major benefit when deficits are still quite high.
The world’s greatest living investor, Warren Buffett, revealed that he has advised his wife to invest in a low-cost index fund rather than bother with stock pickers after his death.
In a characteristically frank letter to shareholders, the famed investment manager, who made his name as a stock picker, argued active management was rarely worth the money. “The long-term results from this policy (of investing in index funds) will be superior to those attained by most investors whether pension funds, institutions or individuals who employ high-fee managers,” he said.
In his 2017 annual letter to investors the Berkshire Hathaway chief executive wrote to investors considering active investing: “The problem simply is that the great majority of managers who attempt to over-perform will fail.”
Look at it this way – if Buffett has outperformed the index, the total of the other active managers must have underperformed (because trackers + Buffett + everyone else = total market, and trackers are some fraction of of the total market). So what he says makes sense while he’s alive….
What Warren Buffett has said will also make sense when he is not alive.
Here are five of his quotes:
Most of these come from his past letters to shareholders, noted by year, except for one which happened to be in conversation with Vanguard Founder John Bogle, a man Buffett in 2016 called a “hero” to investors for his tireless work promoting low-cost investing.
1. High fees create low returns
“When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.” (2016)
2. The goal of the amateur investor
“The 21st century will witness further gains, almost certain to be substantial. The goal of the non-professional should not be to pick winners — neither he nor his ‘helpers’ can do that — but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal.” (2013)
3. How dumb money gets smart
“By periodically investing in an index fund, for example, the know-nothing investor can actually outperform most investment professionals. Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb.” (1993)
4. How smart money gets dumb
“Huge institutional investors, viewed as a group, have long underperformed the unsophisticated index-fund investor who simply sits tight for decades. A major reason has been fees: Many institutions pay substantial sums to consultants who, in turn, recommend high-fee managers. And that is a fool’s game.” (2014)
5. Ben Graham on indexing
“A low-cost fund is the most sensible equity investment for the great majority of investors. My mentor, Ben Graham, took this position many years ago, and everything I have seen since convinces me of its truth.” (To John Bogle, in The Little Book of Common Sense Investing)
The tide is turning in the investment world. Trillions of dollars is managed via index funds at extremely low cost and that figure is rising every month.
Bonus round
You might wonder, perhaps, why not all of it? The simple answer, according to Buffett, is ego, as he explained in his 2016 letter to shareholders.
“Over the years, I’ve often been asked for investment advice, and in the process of answering I’ve learned a good deal about human behavior. My regular recommendation has been a low-cost S&P 500 index fund,” Buffett wrote.
“To their credit, my friends who possess only modest means have usually followed my suggestion. I believe, however, that none of the mega-rich individuals, institutions or pension funds has followed that same advice when I’ve given it to them.”
Instead, he went on, “those rich investors give their money to a Wall Street investment manager, who then proceeds to attack that bundle of money with fees while delivering, typically, far below market returns”.
Essentially, these rich folks got free advice from one of the richest men in the world and, without a second thought, did the opposite. Human behaviour, indeed.