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Asset management
Drawing conclusions about the state of “asset management” can be tricky, since there are different trends at work among traditional long-only managers, hedge funds, and the purveyors of private capital strategies.
Focusing on the first category, the title of a BCG paper says that “The Tide Has Turned” — “with major implications for the business model that has served the global asset management industry so well in the past.” It highlights five pressures: the lack of organic growth, the increasing popularity of passive funds, compression in fees, rising costs, and lower rates of new product survival. The firm outlines cost containment, adding alternative strategies (despite the slowdown in activity in that already-clogged market), and personalizing offerings as the best moves for managers to make now.
A pair of articles by Michael Thrasher for Institutional Investor illustrate that the message hasn’t gotten through. The first reports on a study by Northern Trust and Coalition Greenwich, which says that “there is a gap between how firms ought to be preparing and the actual level of preparation”:
Even though 84 percent of managers expect that they will grow, just 22 percent plan to make changes necessary to their operating models to achieve efficiency and cost savings.
The other story cites Scott Gockowski of Casey Quirk as saying that large layoffs are unlikely, that “purges still aren’t happening in asset management businesses, and for good reason.” He added, “I think a lot of managers have kind of made their decision and are in an okay place for now, as long as markets stay where they are.”
In “The Triumph of Fund Shareholders,” John Rekenthaler of Morningstar contrasts the strong performance of fund company stocks from 2003 to 2013 with the subpar results over the last decade. A picture of mutual fund costs tells the tale, with the average weighted expense ratio falling by more than half, due to increased use of passive, as well as declines in active fees (from 92 basis points to 60). In effect,
fund shareholders repealed the traditional math. By demanding much-reduced expense ratios, they received moneys that would otherwise have gone into the industry’s coffers.
Two tribes
The headline for a Wall Street Journal article: “Inside the Escalating Feud at One of Wall Street’s Biggest Hedge Funds.” The co-founders of Two Sigma disclosed in a securities filing that the Management Committee (comprised of the two of them) has “been unable to reach agreement on a number of topics.”
The quant firm describes itself as “the best place for nice geeks to work.” And a blog posting featuring its employees describes Two Sigma’s “strong culture of curiosity.” Yet, within the firm, “It’s two tribes,” according to an anonymous source for the WSJ story.
As an investor, what should you make of this? As an employee? Will a fractured culture — between the principals, and between the narrative and reality — matter in the end?
Private credit
According to Moody’s (as reported in the Financial Times):
The $1.4tn private credit industry faces its “first serious challenge” as tens of billions of dollars of loans underwritten at the top of the market in 2021 are strained by sharply higher interest costs and a slowing economy.
The rating agency called out two of the largest players in private credit — Ares and Owl Rock — although neither firm was downgraded. The overall growth in strategies has been phenomenal since the financial crisis (see “The Private Credit Boom” chart on this Moody’s site). A reappraisal is in order given the stampede into the area and a dramatic change in conditions.
Adams Street, which offers private credit, believes “In Private Credit Manager Selection, the Devil is in the Diligence.” It says:
Look for private credit managers with three key characteristics to avoid losses and produce alpha — a proven approach to underwriting, a differentiated approach to originating and winning deals, and a capital base that matches their opportunity set.
No doubt the firm feels like it fits the formula, but what is “a proven approach” in an environment unlike any other that these firms have seen? One section of the report: “Leverage Can Be a Double-Edged Sword.”
Along that line, Stephen Clapham quoted Jim Grant: “Private credit is a manifestation of the imperative to build leverage.” What will come of that building project now?
Flashback
In 1949, Alfred Winslow Jones, the father of the hedge fund industry, wrote “Fashions in Forecasting,” an article published by Fortune. It reported on “technicians” of the day, “rising competitors of the Dow Theory, whose very popularity may have impaired its own usefulness.” (A never-ending phenomenon in markets.)
Other reads
“Magic Mushrooms. LSD. Ketamine. The Drugs That Power Silicon Valley.” Kirsten Grind and Katherine Bindley, Wall Street Journal. On attempts to “expand minds, enhance lives and produce business breakthroughs.” (Also see a short 2009 Research Puzzle posting on “pharmaceutical alpha.”)
“Bank of England to Apply Stress Tests to Pension Funds, Hedge Funds, Asset Managers,” Michael Katz, Chief Investment Officer.
The Bank of England has launched an exploratory scenario exercise intended to improve understanding of the behaviors of banks and other financial institutions during times of stressed financial market conditions. . . . Participating firms will include large banks, insurers, pension funds, hedge funds and funds managed by asset managers.
“Retired exec: Top 10 things that need to be addressed in institutional investment,” Timothy Barron, Pensions & Investments. “Somewhere along the way, compensation structures were warped into awarding folks for winning now.”
“AI and the Investment Management Process,” Tom Abrams and Nina Piper, FactSet.
Investment professionals need good ideas and timely, accurate explanations of what has been and is happening. Investment decision-making is a low signal-to-noise business — innumerable amounts of numeric and textual data but only a few actionable items among them — compared to many applications of AI that are higher signal to noise (image recognition, automated vehicles, speech recognition).
“What Can the CIA Teach Investors?” Joe Wiggins, Behavioural Investment. Insights from Richards Heuer’s Psychology of Intelligence Analysis.
“Wealth Management’s Double Attrition Problem,” Holly Deaton, RIA Intel.
With more than a third of advisors set to retire in the next decade and rookie advisors washing out at high rates, the industry is facing a reckoning.
“AI Fails Insider Trading Test,” Susan Mathews, Integrity Research Associates. “An over-looked danger of AI is its inability to apply a legal test to a unique set of facts.”
“Quant hedge fund primer: demystifying quantitative strategies,” Aurum. Five strategies are summarized via descriptions, signal types, performance characteristics, sample trades, and risk/return profiles.
“Fifty Years Ago, Rusty Olson Began Investing Kodak’s Pension. Thanks to Tom Mucha, He’s Reaping the Rewards.” Alicia McElhaney, Institutional Investor.
“I don’t think I concerned myself with conventional practice,” Olson says. “Our portfolio looked so different from most other pension funds, what was the point in looking at other pension funds? We just wanted to make money.”
“Vanguard pays out profits to C-suite despite bear market,” Jeff DeMaso, Citywire Pro Buyer. “Vanguard is not, and has never been, a non-profit, though much of the language around ‘operating at cost’ does at times make it sound as though they are.”
“Why do people hire their financial advisors?” Danielle Labotka and Samantha Lamas, Morningstar. Emotional reasons outweigh financial reasons.
“Of Black Swans and White Chipmunks,” William Bernstein, Advisor Perspectives. “Few financial topics grab more media attention than money managers who make gobs of money while everyone else suffers.”
“5 Things That Separate the Best Workplace Cultures From The Rest,” Gustavo Razzetti, Fearless Culture.
Workplace culture precedes business results. People often talk about culture as something abstract, almost invisible. However, its impact on the work is anything but invisible. Culture can get the best or worst out of people.
“Wall Street has a new favourite phrase and it’s utterly nauseating,” Louis Ashworth, Financial Times. Sell-side analysts want more information (apparently).
Slow to change
“Perhaps more so than individuals, organizations find comfort in familiarity, as processes become etched into routines, accounting and finance systems, compliance procedures, and other forms of rituals — and they are slow to change.” — Dilip Soman, et. al, in “The Between times of Applied Behavioral Science,” part of The Behavioral Economics Guide 2023.
Tracking error
There isn’t anything surprising in this graphic from Qontigo, but it is a reminder that “controlling tracking error theoretically limits both our potential upside and our potential downside.” As such, it is a good exhibit to use when discussing investment policy, especially with governing board members for whom tracking error is an abstract concept. (Of course, there are assumptions about normality and the stability of the tracking error built into this simple exercise.)
For those directly involved in selecting managers, the image serves as a reference point for discussions about tracking error (which often is included as a variable by those screening for managers) — and what it takes in terms of methodology to get above that zero line over time.
Postings
The series on “Anthropology and Investment Organizations” drew to a close with two postings:
“The Homophily of Hedge Fund Culture” addresses the lack of diversity in the investment industry by looking at a part of the business where it is particularly noticeable.
“Ethnography and Investment Analysis” offers some closing thoughts about the power of cultural evaluations and their importance in understanding the upheavals ahead.
All of the content published by The Investment Ecosystem is available in the archives.
Thanks for reading. Many happy total returns.
Published: July 3, 2023
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