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The
Peculiar Asset Management
Industry
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Asset management is a highly unusual and somewhat baffling industry. We
see seven main examples of just how peculiar our industry is, relative
to other industries:
1. The asset management industry collectively plays a
near-zero-sum
game. By contrast, most industries are positive sum: if you
eat a great steak dinner, it doesn’t imply that others have to eat
hamburger. In asset management, each new Money Manager that is able to
generate Alpha (returns above the passive benchmark performance)
normally does so at the expense of other Money Managers who
underperform. Your own investment’s value may change because of a change
in value of the underlying asset and/or market preferences. However, few
investors can impact the value of the underlying asset, except for
typically private equity and venture capital investors. And only
celebrity investors like George Soros can influence market preferences.
In fact, it is mathematically impossible for the median investor in a
given publicly-traded sector to beat a low-cost index of that sector,
after expenses. Money 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) and/or nascent
asset classes
(e.g.,
names,
income,
finance,
currencies,
divorce
loans,
timber,
farms/ranches,
art,
collectibles,
or carbon
credits.
2. The asset management industry rarely delivers the alpha that
it promises. Delivering alpha on a net of fees and costs basis
consistently over many years is incredibly difficult. For example, hedge
funds on average have underperformed on a net of fees basis in both US
equities and bonds since 2000. Hedge fund performance looks attractive
for the period of 1970 - 2013 (See Picture 2). However, one can argue
that hedge funds were different in the 1980s and 1990s as the industry
was smaller and more nimble. Recent hedge fund underperformance, coupled
with steep typical 2% management and 20% performance fees and
additional hidden costs that can be charged to fund investors, make
investors more likely to ask questions.
Picture 2: Relative (Gross & Net) Hedge Fund Performance Over Time: