When does the bleeding stop....does it stop?

Water Cooler Careers
#1

We all know what’s going on in the asset management industry right now. Major outflows from active to passive funds due to several years of nonperformance. When I was in the study mode of my career (college/CFA), I used to always wonder how hedge funds, mutual funds, etc got away with charging the fees they did given mountains of empirical evidence showing they underperformed the market post fees and in some cases pre-fees. Well, now all of a sudden entities, HNW and regular retail investors are recognizing the stats that have been right in front of their faces for years. This has caused:

  • Bye money : $100B+ of hedge fund net outflows. Most since 2009.
  • Closures : 2015 first time since 2009 more hedge funds closed than opened. Same in 2016.
  • Trickled down to the sell-side : CLSA, Brain, middle banks quietly reducing headcount, many other boutiques.
  • Hello AI: Has caused top mng of big firms to take a harder look at alternatives that are getting stronger and cheaper every day, which would be AI. For instance, the asset mng giant Blackrock just let go of 40 in equity research including 7 PMs since the new equity head thinks AI can outperform humans in long run while cutting fees and competing better with the likes of Vanguard.

So all of this means less jobs and less fees, which means less money for all in asset management. So the question at hand is, do things level off at some point and the industry carries on or is this a irreversible structural trend downwards?

For the bull case. One could argue a lot of the nonperformance over the last 10 years was due to the rising tide effect of the raging bull market making it tough to outperform passives and an influx of diluted low talented stock pickers. So as the weak exit and we enter a more flattish market, alpha can return creating inflows back.

For the bear case. Even if the above bull case is true, one could argue that perception is harder hit than performance. Meaning, even if HF’s, mutual funds, and the like generate alpha over the next few years, investors may look at it as an aberration just as they thought for years when firms underperformed it was just an aberration and kept blindly plowing money in. Also, based off recent actions of big asset mng firms, we seem to be at the early stages of a price war. Why shall I pay you 2% annual plus load or whatever to pick 70 large cap names when I can buy 500 large caps for essentially free? Do I have confidence you can in long run earn your fees + alpha? And last, like many industries, AI brains continues to exponentially rise. And you can now plug their brains into a vast network of data (twitter, google, facebook, etc.) to track, analyze, and compliment other calculations to run like valuation, technical analysis, etc. As intelligence continues to increase and cost continue to come down, its a logical alternative. Yes, for a long time there will may be some role for humans, but skeptical of how much.

I’m very interested to here all your thoughts? I know I’m painting a gloomy picture, but I am still early in my career and this kind of stuff worries me. If your later in your career, you probably just shrug this it off to a degree I would imagine.

#2

I’m more for the bull case you described, the market is not efficient, weak stock pickers will get weeded out over time and only the best guys with the right incentives will be able to make it.

#3

Weak stock pickers are required in order for there to be strong stock pickers. This is a simplification, but not counting fees, excess returns in the market from active management need to be zero. In fact, if there are a lot of exceptionally bad stock pickers, the number and magnitude of outperformance of successful stock pickers should also increase. This could lead to anecdotes of “that hedge fund” that obtained outsized returns and lead more investors into the market - investors are greedy and chase lottery tickets after all. Like Neo and Agent Smith, bad and good stock pickers both need to exist.

#4

whats love without tragedy(Marilyn Monroe)

#5

Bear case for me; AM/HF has charged too much for too long. Those who focus primarily on short-term trades also seem destined to fail. Take the example of PE; parts of the industry are drastically changing from the LBO/financial transactional model to driving value via improved operations. What a novel concept!

#6

That’s a good point, but how can we have a sustained healthy market when only the top 5-10% each year beat their index and that is in isolation. Meaning the ones who beat one year, don’t necessary beat the following year. So maybe only less than the top 1% can consistently beat. And that is the root of the problem. Why shall people start flowing their capital back to asset managers knowing the chances they get sustained alpha is close to a lotto ticket?

#7

they need to change definition of what active means. most “active” pms have 100 positions which is why they are really closet indexers then they charge ridic fees, which is why they underperform. real stock pickers should only have 5 to 25 stocks. they could be valuing/following 100 cos, but odds are they will only invest on the ones with best risk reward and be concentrated in those positions.

http://www.valuewalk.com/2015/11/39-of-stocks-have-a-negative-lifetime-total-return/

#8

“you can trust anything that bleeds for 5 days and doesnt die”

#FreeCvM

#9

Long/short beta-neutral strategy could hardly beat 8 years or straight bull market (mostly fueled by stimulus rather than fundamental economic changes). I guarantee you the first year $SPY turns negative HFs will be back shining.

With regards to the machines, although they are faster and cheaper the algos are exploitative by definition. Having said that, I do believe the stock market will sooner or later be dominated by AI. The same, however, stands for the computer science, medicine, research, etc. So no point to be worried; rather try to take an active role in this transformation :slight_smile:

#10

And now Avondale just closed shop today as well…

#11

I don’t think active management is going away, but it is transforming.

First, take a moment to look at fixed income, nobody index their bond portfolio - why should you? you can increase yield and manage duration exposure by moving away from treasuries, especially in this low yield and rising interest rate environment.

Peter Lynch’s hay day was the early-to-mid 90s… Emerging Markets were still really “emerging markets”, and Int’l Equities were just an after thought, as we just had the Tequila Crisis, Japan just went bust, and western europe was just forming after the fall of the USSR. Private Equity and hedge funds were just really starting out and too unproven for most. How can you not go wrong with a domestic stock and bond portfolio?

Now we have… private equity, multiple flavors of hedge funds, core/core plus/value-add real estate, emerging markets, frontier markets, real assets, HY, EMD, CDOs, CLOs, etc. Yet, investor’s problems increased, people need yield, are looking to meet target returns, and to make sense of all the new risk out there.

Now there are new risk factors (political, macro, etc) - questions like “what happens after brexit?”, “what if we get protectionism?” how will that impact my portfolio? How should I adjust my asset allocation? Should I buy core RE? How will I meet my target return under that scenario?

So, the world transitioned from stock pickers to a mix of “asset allocators / risk managers / economists”.

#12

^I certainly don’t disagree with what you are saying. That said, this still doesn’t explain why many designated equity funds charges high fees and yet do not seem to consistently outperform their benchmark.

To me, the simple answer is that there are just a lot of bad managers or it is essentially impossible to generate alpha consistently over a long enough time-line because we are predicting the future and the future is unpredictable.

#13

It’s alot of bad managers with good pedigree (on paper). Having an ivy league degree doesn’t make you a good investor, otherwise there would be hundreds of thousands of Buffets. Unfortunately perception is reality and pedigree matters alot in this business.

#14

:confused:

"The CFA requires at least 900 hours of study to pass all three levels and this, together with the low pass rate, means its something of a ‘badge of honour’ as well as career aid. But there are over 140,000 people with a CFA charter now, and it’s one of the reasons that active asset management is struggling.

At least that’s according to Vanguard CEO, Bill McNabb, who said a recent Wharton presentation (picked up by Bloomberg) that the “professionalisation” of the industry has made it harder for active fund managers to gain an edge over the competition. 68% of investor funds are now professionally managed – compared to 20% in 1963 when the CFA was launched. At that time, there were just 284 CFA charterholders, whereas the number holding the qualification has risen by 76% in the past ten years, and students are kicking off level one alongside their degrees. In other words, active asset managers are competing against one another, and failing, so investors are embracing passive investment strategies instead."