17 July 2016
By Stephen Foley, Source: FT.com
To an audience of financial advisers who had come to hear the hottest stock tips from the big stars of the fund management industry, it was a startling thing to say: "If somebody asked me to make the argument for active management, I would find it difficult given the statistics."
But active managers, those whose funds must try to beat the market rather than simply track the index, are facing something approaching a crisis.
A majority fail to beat the index over any significant period, and most of those that do ultimately find their outperformance to be fleeting. New competitors are claiming any insight they actually possess can be replicated by a computer. Clients are shifting en masse to index-based funds - active funds have lost
The panel at the
"The managers that tend to outperform have certain characteristics in common," he said. "They tend to be longer term in nature, not traders. They are willing to be different to the benchmark. Most importantly, they also tend to have a lot of skin in the game."
Some see the changes as an opportunity.
The comments are a reminder that stockpicking as a career has always required an uncommon degree of self-belief. Never more so than now. Clients have imbibed the evidence of studies such as the latest annual Spiva survey from S&P, which shows that 83 per cent of US mutual funds and 86 per cent of European funds have underperformed the market over the past decade, and Morningstar's own work suggesting that today's top performing managers are no more or less likely to be among the top performers of the next few years.
The result: index-trackers already account for 40 per cent of the $9tn in US equity mutual funds and exchange traded funds, and the shift is accelerating.
Savers who have paid high fees and failed to get even market returns will hardly be upset if the industry emerges from a period of upheaval with fewer businesses, lower profits and fewer people, if they end up paying less and getting better returns.
There are debates, however, about whether fair prices for assets can be discovered if too high a proportion of the money is simply tracking the index. And active management remains a large employer, running and supporting 100,000 mutual funds around the world and countless more portfolios for institutional investors - a veritable
Asset management remains an uncommonly profitable business, with operating margins of 37 per cent in 2015 and profits that topped
Managers have been keeping a lid on costs by limiting the growth and pay of sales forces and cutting operating expenses. But
A year ago,
"Firms will keep a sharper eye on where there are products and areas where they are sub-scale, and think whether they should close them, since they will not see the same margin or the same upside now,"
The open question is whether the industry will respond with mergers and acquisitions aimed at cutting costs faster. Chief executives have traditionally scoffed at the idea of megadeals, saying it is important to preserve unique cultures. However, there has been a notable change of tone among some industry leaders.
"This is as disruptive a time as I have seen in this industry. Every CEO has to take a step back," he says. "There are a lot more conversations out there about what could happen than has ever been the case. This is an industry that arguably has excess capacity, particularly when the performance of active management has been inconsistent."
Much will depend on the attitudes of shareholders, and whether they are willing to tolerate lower margins in return for higher dividends and share buybacks, or whether they will force companies to keep profits up.
"We all have to try to protect our margins, but the reality is they [margins] are going to come down,"
Money managers are still willing to invest in areas where they see growth opportunities. These are often one stage up from the traditional fund level, however. Instead of touting individual products, they approach clients offering to use their funds as building blocks, charging them instead for asset allocation expertise, risk management consulting or other services.
Standing out from the human crowd is one thing to worry about. Another is the race against the machine. Even alpha- or at least a good deal of it - can be replicated by computers, academics claim. The analytical work and gut instincts of the consistently successful stockpickers might actually boil down to simple bias for value stocks, momentum investing or one of the other factors that have been proven to outperform market capitalisation-weighted stock indices.
The "quants" - who build investing algorithms rather than form opinions on company prospects - are as bullish as the traditional active managers are nervous for their futures.
QMA, a quant asset manager, uses the latest issue of the
While insisting on great respect for active managers, some fund management groups have gone down this route themselves.
For the humans, it can be an exhausting race up the value chain. Marketfield Asset Management's
"You could be betting your career, and the bias in our industry is that there is very little incentive to do that," he says.
This may be the new lot of the active fund manager, driven to take more concentrated risks. It is what successful stockpickers like
As for the investors, there are no guarantees that results will end up being any better on average, and every chance that the ride will be scarier for them, too. Ironically, just before its conference this year, Morningstar stripped
Passive funds are "boring", says
The industry veteran, who sold his first company to Investec in 1998, is still so bullish on asset managers that he even runs a little fund which invests in their shares - and he does not shy away from active managers. In fact, his fund buys shares in firms whose funds have seen strong performance, on the belief that client inflows, and higher revenues, will soon follow and boost the share price.
What is it that gives
He does not doubt that stockpicking success will be rewarded. "When do people buy funds? When they have a track record that is better than the next guy's," he says. "For all the academic studies that say past performance does not equal future performance, I don't think that aspect of human nature is going to change."
Additional reporting by
Copyright The Financial Times Limited 2016
(c) 2016 The Financial Times Ltd. All rights reserved. Please do not cut and paste FT articles and redistribute by email or post to the web.