4 Special reportAsset management The EconomistNovember 14th 2020
2 average height or intelligence. In any year,
some will do better than the index and
some worse. But evidence of sustained out-
performance is vanishingly rare. Where it
exists, it suggests that bad performers stay
bad. It is hard to find a positive link be-
tween high fees and performance. Quite the
opposite: one study found that the worst-
performing funds charge the most.
Why do investors put up with this? One
explanation is that investment funds are
more complex than breakfast cereals. At
best they are an “experience good” whose
quality can be judged only once consumed.
But they are also like college education or
medical practice: “credence goods” that
buyers find hard to judge immediately.
Even well-informed investors find it tricky
to distinguish a good stockpicker from a
lucky one. Savers are keen to invest in the latest “hot” funds. But
studies by Erik Sirri and Peter Tufano in the 1990s show that, once
fund managers have gathered assets, those assets tend to be sticky.
They are lost only slowly through bad performance.
Firms have a fiduciary duty to act in the best interest of custom-
ers. Securities regulators (eg, the Financial Conduct Authority
(fca) in Britain and the Securities and Exchange Commission (sec)
in America) oversee asset managers. Unlike banks, which borrow
from depositors and markets, asset managers are unleveraged and
so not subject to intensive rules. The assets belong to beneficial in-
vestors; they are not held on a firm’s balance-sheet. The thrust of
regulation is consumer protection from fraud and conflicts of in-
terest. It does not prescribe investment strategies or fees. An in-
vestigation by the fcain 2016 found that investors make ill-in-
formed choices, partly because charges are unclear. The problem
of poor decision-making is most acute for retail investors. But
even some institutional investors, notably those in charge of small
pension schemes, are not very savvy. Around 30% of pension
funds responding to a survey by the fcarequired no qualifications
or experience for pension trustees. Investors are a long way from
the all-knowing paragons of textbook finance theory.Medical manners
A paper in 2015 by Nicola Gennaioli, Andrei Shleifer and Robert
Vishny argued that fund managers act as “Money Doctors”. Most
people have little idea how to invest, just as they have little idea
how to treat health problems. A lot of advice doctors give is generic
and self-serving, but patients still value it. The money doctors are
in the same hand-holding business. Their job is to give people the
confidence to take on investment risk.
In asset management, as in medicine, manner and confidence
are as important as efficacy. “Just as many patients trust their doc-
tor, and do not want to go to a random doctor even if equally qual-
ified, investors trust their financial advisers and managers,” say
Mr Shleifer and his co-authors. This may explain why investors
stick with mutual-fund managers even in
the face of only so-so performance. As long
as asset prices go up, a rising tide lifts most
boats in the asset-management industry—
including a lot of leaky vessels.
But the seas are getting rougher. Over
the past decade, investors have placed
more capital with low-fee “passive” funds.
These funds invest in publicly listed stocks
or bonds that are liquid—that is, easy to
buy or sell. The most popular are “index”funds, run by computers, that track bench-
mark stock and bond indices. The indus-
try’s big winners have been indexing
giants whose scale keeps costs down and
fees low. The two largest, BlackRock and
Vanguard, had combined assets under
management of $13.5trn by the end of 2019.
The losers were active managers that try to
pick the best stocks.
High fees have not disappeared. The
boom in passive investing has spawned its
antithesis: niche firms, run by humans, in
thinly traded assets charging high fees. A
growing share of assets allocated by big
pension funds, endowments and sover-
eign-wealth funds is going into privately
traded assets such as private equity, prop-
erty, infrastructure and venture capital.
What has spurred this shift is a desperate
search for higher returns. The management of private assets is an
industry for boutiques rather than behemoths. But it has its own
big names. A quartet of Wall Street firms—Apollo, Blackstone, Car-
lyle and kkr—have captured much of the growth in assets allocat-
ed to private markets.
The shake-up in asset management owes a lot to macroeco-
nomics. The investors who snapped up certificates in Rose’s trust
were dissatisfied with 2% interest in the money markets. Today in-
vestors would sell their grandmothers for such a yield. Interest
rates in parts of the rich world are negative. In Germany and Swit-
zerland, government-bond yields are below zero across the curve,
from overnight to 30 years. Inflation is absent, so ultra-low inter-
est rates are likely to persist. The expected returns on other as-
sets—the yields on corporate bonds, the earnings yields on equi-
ties, the rental yield on commercial property—have accordingly
been pulled down. The value of assets in general has been raised.
The steady decline of long-term rates is a nightmare for pen-
sion funds, because it increases the present value of future pen-
sion promises. Industry bigwigs often blame the Federal Reserve
and other central banks. But interest rates have been falling steadi-
ly since the 1980s. There are deeper forces at work. The real rate of
return is in theory decided by the balance of supply and demand
for savings. The balance has shifted, creating a bonanza for asset
managers, whose fees are based on asset values.
There are competing explanations for the savings glut. Demo-
graphy is one: people are living longer, but average working life has
not changed much. More money must be salted away to pay for re-
tirement, with much of the saving taking place in the years of peak
earnings in middle age. A bulge in the size of the middle-age cohort
has pushed the supply of savings up. Another factor is the growth
of China and other high-saving emerging markets. At the same
time, the demand for savings has fallen. When Robert Fleming set
up his investment trust, enterprises like railways were capital-in-
tensive. Today the value of firms lies more in ideas than in fixed
capital. Big companies are self-financing. Small ones need less
capital to start and grow. The upshot is that more money is chasing
fewer opportunities. Investors are responding by trying to keep
fund-management costs down and putting more money into priv-
ate markets in hopes of higher returns than in public markets. This
response is reshaping the asset-management business.
This special report will consider the outlook for the industry
and ask what it means for the economy, for the stewardship of
firms, for capital allocation and for savers who place their trust in
the money doctors. It will examine whether China’s untapped
market can be a source of renewed growth. A good place to start is
with the forces shaping the industry’s elite. 7Passive aggression
United States, fund flows, $bnSource:Morningstar *ToSeptember800
600
400
200
0
-200
-400
20*152009Active
800
600
400
200
0
-200
-400
20*152009PassiveIn asset manage-
ment, as in medi-
cine, manner and
confidence are
as important as
efficacy