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
\label{the-macro-trends-forcing-change-on-our-industry}
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.