Thursday, December 17, 2015

PWC Alternative Asset Management 2020 - more industrialization of the industry

One of the tenets of capitalism is the close association between growth and economies of scale of firms. Because of economies of scale, firms push for growth in an attempt to lower costs and drive competitors from business. It is the brutal part of competition - grow or die. This competitive drive for growth is not faced by the skilled artisan who produces goods that cannot be easily manufactured or generated through scale. 

There was once a time when hedge fund managers were viewed like master craftsmen who used their skill to produce unique return streams.  Quantitative finance has for the most part destroyed the hedge fund manager as master craftsman through the identification and measurement of alternative beta and alphas sources. Alpha can now be created through scale. Beta can be separated from alpha. The creation of true skill alpha from the manager artisan has been minimized or marginalized 

Additionally, the institutionalization of the hedge fund industry has moved it from a clientele of sophisitcated investors to a much broader base for the masses. The requirements from due diligence have also required scale to spread the costs and meet the growing demands for operational structure. 

This dynamic environment provides background for reading PWC Alternative Asset Management 2020, another forecast for the alternative asset  management industry. PWC uses an interesting catch phrase, "from institutional quality to industrial strength", to describe the direction of alternative investments. The artisan does not have industrial strength. There may be both more standardization and customization but this is just a response to commoditization. Economies of scale lead to commoditization and in an effort to stop the cycle of lower fees, managers have focused on customization.

The picture for the alternative investment industry is much grimmer than portrayed in this look into the future. Competition will squeeze the artisan manager. In some cases, this will be good, but it will leave an industry where the average size firm is larger, fees are lower, and uniqueness is rarer. 

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