Of late there has been a great deal written about what value the money management industry, and specifically its most active participants hedge funds, actually add. In one sense active money managers provide society a service by making markets in a very real sense work better. On the other hands money management is a business that is relentless in its pursuit of profits. Recently we have seen the latter as firms look to generate additional fees by pushing hedge-fund like strategies into Mom and Pop’s 401(k) plans.
Stephen Gandel at Fortune notes the launch of the new Goldman Sachs Multi-Manager Alternative Fund that comes with a hefty 3.3% annual expense ratio. This despite the fact that hedge funds have not exactly been killing it performance-wise of late. Nor is Goldman alone in this pursuit. In a recent post we noted the push to get private equity funds available to a broader class of investors. This is not likely to work at well as I wrote:
The danger today is that investors plunging into alternatives are the last ones in the proverbial buffet line getting the “stuff stuck to the tablecloth.” The vast majority of investors can safely ignore alternatives (and other active strategies). Focusing on those things over which investors have some genuine control like their savings rate, fund costs, turnover and taxes is a far better use of their limited time and energy.
Despite the shaky performance picture there is no shortage of managers looking to get into the hedge fund business and investors looking to play their money with the newest hot manager. The problem is in trying to identify managers that after their hefty fees actually outperform. Barry Ritholtz writing at the Washington Post recently wrote:
Here is the crux of the issue with hedge funds. A small percentage have significantly outperformed the markets; an even smaller percentage have done so after fees are taken into account. While we all know which ones have outperformed over the past few decades, no one has even the slightest clue which ones will outperform over the next one.
Every fund in the world warns that past performance is no guarantee of future results. It is too bad that investors refuse to believe it.
One could argue that the entire money management industry is really built on selling hope versus generating real alpha. As Burton Malkiel wrote in a piece at the Journal of Economic Perspectives:
The major inefficiency in financial markets today involves the market for investment advice, and poses the question of why investors continue to pay fees for asset management services that are so high. It is hard to think of any other service that is priced at such a high proportion of value.
Not everyone is convinced by Malkiels’ argument. John Cochrane in the same issue of the Journal of Economic Perspectives notes that the continued existence of high fee management is a puzzle but is skeptical that is necessarily a sign of market failure. Justin Fox writing at HBR takes Malkiel’s point and pushes it farther:
Malkiel is basically saying that the asset-management industry has no economic justification for being as big and rich as it is. He’s probably right about that, although I wouldn’t say his evidence is conclusive. The way he purports to show that markets haven’t become more efficient through the years is simply that mutual funds found it just as hard to beat the indexes in 1980 as they do now. And the troves of performance and expense data available for mutual funds allow us to subject them to scrutiny not really possible for most industries.
The funny thing is that despite decades of performance data investors continue to invest in high cost, actively managed products that on average are doomed to underperform the market. Maybe some people simply feel guilty about getting a free ride off of the labors of other investors, although I doubt it. In a recent post on the implications of increasing assets under index management I wrote:
Index funds do nothing to help promote security pricing. However for the moment there seems to be no shortage of investors who are willing to step up with their dollars, and pay higher fees in the process, to try and capture some of this alpha. As the data shows alpha is an elusive beast for even the highest profile managers and is indeed promised to no one.
It this pursuit of ever elusive alpha that drives some many investors crazy over time. Maybe they should be focusing on something else entirely. Let’s let Josh Brown at the Reformed Broker close things out:
Don’t run around chasing stock-picking cats if you don’t need to. If you’re not running a fund benchmarked to an index, alpha generation should not be your priority – peace of mind should.
That is why active management is difficult for us to wrestle with. There is no let up. Active strategies need constant monitoring and upkeep. So in a very real sense if peace of mind is the goal, then a relentless pursuit of alpha is not for you.
Items mentioned above:
Goldman pushes hedge funds for your 401(k). (Fortune)
Alternative investments are no longer all that alternative. (Abnormal Returns)
Asset management fees and the growth of finance. (Journal of Economic Perspectives)
Finance: function matters, not size. (Journal of Economic Perspectives)
Just how useless is the asset management industry? (HBR)
The supply and demand of alpha is not static. (Abnormal Returns)
Chasing the cat. (Reformed Broker)