in mar 1868 a prospectus appeared for a new kind of mny-mkt scheme. the foreign & colonial government trust ‘d invest £1m ($5m atta time) in a selection of bonds. for £85 an investor ‘d buy one of 11,765 certificates giving an = share. the trust promised a 7% yield. its aim was t'give “the investor of moderate means the same advantages as the large capitalist in diminishing th'risk of investing…by spreading the investment over a № of ≠ stocks.” the modern asset-management industry was born.
a week l8r the economist ran a leading article broadly welcoming the new trust. but—setting the tone for 150 yrs of financial punditry—it quibbled bout the selected bonds. a chunk was allocated to turkey and egypt, countries that “will go on borrowing as long as they can, n'when they cease to borrow, they will also cease to pay interest.” fears were expressed that € was disintegrating. “in lending to italy, you lend to an inchoate state; and in lending to austria, you lend to a ‘dishevelled’ state; in both thris danger.”
the trust was the brainchild of philip rose, a lawyer and financial adviser to benjamin disraeli. his idea offa pooled investment fund for the middle class caught on. in 1873 robert fleming, a dundee-based businessman, started his own investment trust, the 1st scottish, modelled on rose’s fund but witha bolder remit. twas largely vested'na mortgage bonds of railroads listed in new york. the holdings were in usds, not sterling. and whereas rose’s trust was a buy-and-hold vehicle, the trustees of the 1st scottish reserved the rite to add or drop securities as they saw fit.
rose’s trust survives to this dy, but asset management is now a far bigger business. over $100trn-worth of assets is held in pooled investments managed by professionals who charge fees. the industry is central to capitalism. asset managers support jobs and growth by directing capital to businesses they judge to ‘ve the best prospects. the returns help ordinary savers to reach their financial goals—retirement, education and so on. so asset management also has a crucial social role, acting as guardian of savings and steward of firms those savings are entrusted to.
tis a business unlike any other. managers charge a fixed fee onna assets they manage, but customers ultimately bear the full costs of investments that sour. profit margins in asset management are high by the standards of other industries. for all the talk of pressure on fees, typical operating margins are well over 30%. yet despite recent consolidation, asset management is a fragmented industry, with no obvious exploitation of mkt power by a few large firms and plenty of new entrants.
in many industries firms avoid price brawl by offering a product distinct from their rivals—or, at least, that appears distinctive. breakfast cereal is mostly grain and sugar, but makers offer a proliferation of branded cereals, with subtle variations na' theme. asset management aint so ≠. firms compete in mkt, in dreaming up new essentialisms and, above all, on their skill in selecting securities thall rise in val.
the industry has not performed well. ever since a landmark paper by michael jensen in 1968, countless studies ‘ve shown that managers of equity mutual funds ‘ve failed to beat the mkt index. arithmetic is against them. tis as impossible for all investors to ‘ve an above-μ return as for everyone to be of above-μ h8 or intelligence. in any yr, some will do betta tha' the index and some worse. but evidence of sustained outperformance is vanishingly rare. where it exists, it suggests that bad perelders stay bad. tis hard to find a + link 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 s'dat investment funds are + complex than breakfast cereals. at best they are an “experience good” whose quality can be judged 1-ly once consumed. but they are also like college education or med practice: “credence goods” that buyers find hard to judge immediately. even well-informed investors find it tricky to distinguish a good stockpicker from a ♣y one. savers are keen to invest inna l8st “hot” funds. but studies by erik sirri and peter tufano inna 1990s show that, once fund managers ‘ve gathered assets, those assets tend to be sticky. they are lost 1-ly sloly through bad performance.
firms ‘ve a fiduciary duty to act inna best interest of customers. securities regulators (eg, the financial conduct authority (fca) in britain na securities and xchange commission (sec) in america) oversee asset managers. unlike bnks, which borrow from depositors and mkts, asset managers are unleveraged and so not subject to intensive rules. the assets belong to beneficial investors; they aint held na' firm’s balance-sheet. the thrust of regulation is consumer protection from fraud and conflicts of interest. t'does not prescribe investment strategies or fees. an investigation by the fca in 2016 found that investors make ill-informed choices, ptly cause 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 lil pension schemes, aint very savvy. round 30% of pension funds responding to a survey by the fca required no qualifications or experience for pension trustees. investors are a long way from the all-knowing paragons of textbook finance theory.
a paper in 2015 by nicola gennaioli, andrei shleifer and robert vishny argued that fund managers act as “mny drs”. most pplz ‘ve lil idea how to invest, just as they ‘ve lil idea how to treat health problems. a lotta advice drs give is generic and self-serving, but patients still val it. the mny drs are inna same hand-holding business. their job is t'give pplz the confidence to take on investment risk.
in asset management, as in med, manner and confidence are as primordial as efficacy. “just as many-pay shunt's trust their dr, and do not wanna go to a random dr even if =ly qualified, 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 inna face of 1-ly so-so performance. as long as asset prices go up, a rising tide lifts most boats inna asset-management industry—including a lotta leaky vessels.
but'a seas are gettin rougher. ‘oer the past decade, investors ‘ve placed + capital with lo-fee “passive” funds. these funds invest in publicly listed stocks or bonds tha're liquid—that is, easy to buy or sell. the most pop are “index” funds, run by computers, that track benchmark stock and bond indices. the industry’s big victors ‘ve been indexing giants whose scale keeps costs down and fees lo. 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 ‘ve 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 sovereign-wealth funds is goin into privately traded assets s'as private equity, property, infrastructure and venture capital. wha’ 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 t'has its own big names. a quartet of wall street firms—apollo, blackstone, carlyle and kkr—’ve captured much of the growth in assets allocated to private mkts.
the shake-up in asset management owes a lot to macroeconomics. the investors who snapped up certificates in rose’s trust were dissatisfied with 2% interest inna mny mkts. tody investors ‘d sell their grandmothers for such a yield. interest rates in pts of the rich realm are neg. in germany and switzerland, government-bond yields are belo zero across the curve, from overnite to 30 yrs. inflation is absent, so ultra-lo interest rates are likely to persist. the expected returns on other assets—the yields on corporate bonds, the earnings yields on equities, the rental yield on commercial property—’ve accordingly been pulled down. the val of assets in general s'been rezd.
the steady decline of long-term rates is a nitemare for pension funds, cause it increases the present val of future pension promises. industry bigwigs often blame the federal reserve nother central bnks. but interest rates ‘ve been falling steadily 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 vals.
there are competing explanations for the savings glut. demography is one: pplz are living longer, but μ working life has not changed much. + mny must be salted away to pay for retirement, with much of the saving taking place inna yrs of peak earnings in middle age. a bulge inna size of the middle-age cohort has pushed the supply of savings up. another factor tis growth of china nother high-saving emerging mkts. atta same time, the demand for savings has fallen. when robert fleming set up his investment trust, enterprises like railways were capital-intensive. tody the val of firms lies + in ideas than in fixed capital. big companies are self-financing. lil ones need less capital to start and grow. the upshot s'dat + mny is chasing fewer opportunities. investors are responding by trying to keep fund-management costs down and putting + mny into private mkts in hopes of higher returns than in public mkts. this response is reshaping the asset-management business.
this spesh reprt will ponder the outlook for the industry and ask wha’ it means for the economy, for the stewardship of firms, for capital alzone and for savers who place their trust inna mny drs. 'twill examine whether china’s untapped mkt can be a src of renewed growth. a good place to start is w'da forces shaping the industry’s elite.■
this article appeared inna spesh reprt section of the print edition under the headline “the mny drs”
original content at: www.economist.com…