If investors complain about Wall Street 80 years ago, they howl now. Industry players are getting richer and richer, while many investors are seeing lackluster results after fees.
Asset management is a very unusual and somewhat confusing industry. Here are six prime examples of how unique this industry is.
The asset management industry rarely delivers on its promises: Alpha
Alpha is a zero-sum game, according to Bridgewater founder Ray Dalio. In contrast, most industries are positive-sum: if you eat a good steak dinner, that doesn’t mean everyone else has to eat hot dogs. In asset management, every new fund manager that generates alpha (returns above the benchmark’s passive performance) does so at the expense of other underperforming managers.
The value of your own investment may change due to a change in the value of the underlying asset and/or market preferences. However, few investors can have a direct impact on the value of the underlying asset, with the exception of private equity and venture capitalists with portfolio acceleration strategies. Famous investors like George Soros can influence market preferences, but most of us don’t have that advantage.
Diversity and inclusion are the easiest problems to solve, and the inevitable aging of the industry’s “pale, masculine, outdated” leaders will create room for new entrants.
In fact, it is mathematically impossible for the average investor in a given industry to beat a low-cost index in that industry after expenses. We would say that fund managers playing a positive-sum game include those who focus on well-developed sectors for which indices are not readily available (e.g. private companies, frontier markets, cryptocurrencies) and /or emerging asset classes.
For example, hedge funds, on average, have underperformed on a net of fees basis for US stocks and bonds since 2000. The HFRI index has returned 18.3% annually over its 10 early years from 1990 to 1999, but only generated 3.4%% per year over the 10 years to 2016. Similarly, according to Morningstar’s Asset/Liability Barometer, in the five years ending in October 2021, only 26.4% of US large-cap, 22.7% of US small-cap and 24.3% of global large-cap active equity mutual funds outperformed their passive competitors.
Rolling 10-year returns have steadily declined across all hedge fund strategies. Picture credits: David Teten
Blue bar: Hedge-Fund Research Institute (HFRI) Weighted Composite Index (HFRI FWD) August 2018 | (Annual Yield HF %).
Green bar: S&P 500 return (Bloomberg).
Blue line: Barclays Hedge AUM Hedge-Fund Industry; 2017 | (Hedge Fund Industry AUM $TN).
“Thanks to better analytics, institutional investors have realized that there is little alpha and that much of the excess returns are explained by risk premia,” said Nicolas Rabener, CEO of FactorResearch.
Amit Matta, a risk management expert, has observed that performance is often overstated (and risk understated) due to the illiquid nature of some of the underlying investments, which allows for favorable price manipulation. .
However, a large group has different goals, businesses. “They represent 50% of the primary market (sellers) and are significant players in the secondary market (M&A), which makes the markets a positive-sum game. It is possible for all asset managers to make money when they buy a successful IPO or sell their stake to an acquiring company. »
Size often hurts returns
Standard compensation models incentivize fund managers to add more assets under management. This contributes to the “winner takes all” trend, where we see an increasing concentration of assets under management among the largest fund managers. The argument is that big hedge funds have the resources and talent to beat the markets. The reality is far from it.
