It’s one of the ironies of asset management that as well as being one of the world’s most dysfunctional industries, it’s also one of the most successful. According to Willis Towers Watson, total assets under management grew by 5.8% in 2016, reaching $81.2 trillion by the end of the year. That means the world’s fund managers now control more money than the total wealth of Europe.
What’s more, the extraordinary growth in global AuM we’ve seen in recent decades is set to accelerate. Another new report, by Pricewaterhouse Coopers, predicts that total assets will rise to $145.4 trillion by 2025.
As TEBI readers know, all this has very little do with the skill of asset managers or the value they’re providing. It’s essentially the product of two related factors — rising asset prices and what the PwC report refers to as “the burgeoning wealth of high-net-worth individuals and the mass affluent”.
In almost every other industry, increased scale tends to result in increased competition and lower costs for consumers. But not in asset management. Yes, we are seeing reductions in fees and charges, but mainly for ETFs and other passively managed products which were already relatively cheap in any case.
The cost of using actively managed funds, by contrast, remains stubbornly high — so high, in fact, that in most cases, fees and charges wipe out any additional value these funds deliver. And remember, because fees are charged on an ad valorem or percentage basis, and because the extra resources required in managing, say, $500 million as opposed to $100 million, are fairly negligible, asset management fees have not stayed constant at all; they’ve effectively risen exponentially.
So, why has this been allowed to happen? Why are consumers still paying such large rewards for industrial-scale failure?
Well, a new academic paper has been published which offers some possible answers. It’s called Some Clarity on Mutual Fund Fees and it’s written by Stewart Brown and Steven Pomerantz.
The argument put forward by Brown and Pomerantz essentially goes like this:
1. A mutual fund is unlike other corporate organisations, in that it has no employees or physical assets. The principal service provider is the fund management company, or sponsor, which creates, manages and markets the fund. “Essentially,” to quote the report, “fund sponsors are in a monopoly position vis- à-vis the funds they operate.”
2. Despite huge rises in AuM, mutual fees have been essentially constant since at least the 1960s. As a result, US investors alone are effectively overpaying to the tune of about $30 billion annually, which in turn has resulted in significant excess returns for shareholders of fund management companies.
3. Despite attempts by politicians and regulators to stop fund management companies exploiting this fundamental conflict of interest, the fund industry has largely managed to maintain the status quo. “The industry,” says Brown and Pomerantz, “has successfully manipulated the political/ regulatory/ judicial system and has maintained advisory fees above market rates for more than 50 years.”
4. The success of the industry lobby can partly be explained by Public Choice Theory. The paper refers to a book by Mancur Olson, The Logic of Collective Action, in which Olson argues that some groups have a larger impact on government policies than others. “People with common interests will generally band together to achieve common goals. However, if the benefits of a political outcome are concentrated in the hands of a few and the costs are diffused among many, the beneficiaries (i.e. fund sponsors) are motivated to influence the political process in their favour. At the same time, those who bear the costs (i.e. consumers) have little incentive to organise to protect their interests.”
Combined with this week’s reports from PwC and Willis Towers Watson, the Brown and Pomerantz report should serve as a wake-up call to politicians and regulators the world over.
It was 14 years ago that the Republican Senator Peter Fitzgerald described asset management as “the world’s largest skimming operation, (with) fund managers, brokers and other insiders steadily siphoning off an excessive slice of (people’s) savings”. Since then, AuM has more than doubled and, despite dismal fund performance, fund sponsors now enjoy far bigger profits than they did then.
Enough is enough. This can’t be allowed to continue.
Robin Powell is an investment writer