4. Money managers can earn more money at less personal risk than in most other industries. Simon Lack reports in The Hedge Fund Mirage that from 1998 to 2010, hedge fund managers earned investment gains net of fees. In the asset management industry, the norm is that the General Partner puts in just 1-2% of the total assets under management and keeps the remainder of her personal assets in a diversified portfolio. Some hedge fund managers have even set up their own sophisticated family offices specifically to diversify their holdings out of the core product in which they made their wealth. In contrast, entrepreneurs in most other fields risk a significant portion of their own capital in their new venture, better aligning incentives.
5. The financial services industry, including asset management, has disproportionate power to create systemic economic risk. This negative externality is unique to financial services, and was particularly obvious in the 2008 financial crisis. Similarly, when the highly leveraged Long Term Capital Management fund collapsed in the late 1990s, sixteen leading financial institutions had to agree on a $3.6 billion recapitalization (bailout) under the supervision of the Federal Reserve. By comparison, when oil prices doubled between 2009 and 2011, it created stress for some industries but there was no concern that the global economy would collapse.
6. The “ broken agency” problem can cost money holders far more than the same problem does in most other industries. All companies face some form of the principal-agent problem: The chief executive of a public company may be tempted to manage financial results to optimize the short term stock price if a significant portion of her compensation comes from company stock options. In asset management, the principal-agent problem is exacerbated by the presence of so many conflicted intermediaries. For example, an individual allocator is often motivated to allocate to the most popular fund or type of investment in which her peers are investing, to protect for career risk. If an allocator hires a known player, underperformance will not cause the employee’s judgement to be questioned. The resulting herd mentality hurts innovation and leads to suboptimal returns.
7. The investment management industry is far more
homogeneous than the clients it serves, ironically for an industry that worships “diversification” as the one true free lunch. Only 10% of mutual fund AUM and 3% of hedge fund AUM are managed by women, and a similarly small percentage is managed by traditionally underrepresented minorities. This, despite the fact that funds run by women outperform. That outperformance equals the cost of money holder bias. Distributors (e.g., Registered Investment Advisors) also are disproportionately white men of middle age and older. The bias has two other main negative effects. First, it limits investors’ understanding of the world. America alone will be a majority minority country by 2040, and inevitably consumption and behavior patterns will evolve accordingly. Second, according to Carol Morley, CEO of the Imprint Group: “It is hard to attract top talent if firms are looking at a small slice of the population and their immediate peer group.”

The Macro Trends Forcing Change on Our Industry

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Global tectonic shifts - technology revolution, globalization, the increased role of women and millennials and a generational turnover among chief investment officers - are an irresistible force meeting a moveable object: the traditional asset management industry structure. (See Picture 4 for a summary.) Meanwhile, asset management shows the traditional earmarks of an industry ripe for disruption — most obviously, unhappy customers and very profitable incumbents.