Saturday, December 3, 2016

FCA Asset Management Market Study - Investors don't get much from managers

I may not have read every page in detail, but the new FCA Asset Management Market Study presented some conclusions that were loud and clear. Investors do not get a lot of value from their active asset managers. Matched up against passive indices as an alternative, you pay more in fees but get less return which translates into significantly lower wealth for investors. Yet, don't cry for these poor asset managers. Active managers make good operating margins and any economies of scale they gain are not passed back to the consumers through lower prices. The only losers are investors.

Investment consultants, who are supposed to be the great givers of advice, don't do a good job at picking managers and may not do a good job of highlighting costs of active management. So much for talent helping to guide investors. Institutional investors may be getting better at measuring what asset managers provide, but even here there could be better work at demanding more competition through pricing that reflect value-added.

I will highlight three graphs that tell the FCA story. The first is the compounded return of active versus passive management after accounting for fee differences. The cost of choosing expensive managers is significant.

Now you may say that the cost could be worth it if the managers perform. A good manger may, during any short period underperform a benchmark but do better over the long-run. This argument would be based on the fact that the active manager takes active bets against a benchmark. Unfortunately, a close look at some active managers is that they don't vary from the benchmark but still charge higher fees. You pay more for the same performance. There are few managers who take large active bets. Simply put, why take active bets when you can hug the benchmark and charge large fees and still have a successful business? Tracking error has too much downside. 

You would think that larger managers who cover their fixed costs would be able to reduce their fees to clients. Don't bet on it. Active managers don't think that lowering fees will attract business and investors are not demanding a discount. Now management fees seem to be an important issue when selecting managers for institutional investors, but retail may not be as aware of these issues. 

The FCA study highlights some key issues with the industrial structure of asset management, but I want to be careful before I agree with any specific solutions. Clearly, the first issue is whether investors have the proper information to compare costs with different investment products. Second, do investors have the right education to understand the information that is provided? On the first issue, more could be done to provide information in a simple direct fashion that includes all costs and their impact. On the second issue, there could be a strong argument that retail investors need more education, but institutional investors should have the ability to assess these issues. Clearly, the role of the investment consultant should be to highlight these costs issues relative to performance. 

I always come back to one of my favorite quotes:

It is difficult to get a man to understand something when his salary depends upon his not understanding it.  - Upton Sinclair 

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