
Asset Managers: The tide turns - dmmalam
http://www.economist.com/news/finance-and-economics/21695552-consumers-are-finally-revolting-against-outdated-industry-tide-turns
======
RockyMcNuts
Active management is an overpriced, tough to beat affair, but if enough people
invest passively, active management will regain the upper hand.

Indexers herd, they reduce liquidity, they push up prices of stocks in the
index, they increase volatility, initially smaller/less liquid stocks have
prices pushed around irrationally, then bigger stocks. It starts to pay to do
private equity, buy out cheap stocks, IPO them, get them back into the index
universe, and sell them back to the indexers.

Indexing is not a silver bullet, it's one strategy in a Nash-like equilibrium.
Too much active investing, passive can match them at a lower cost and
win...too much passive investing, mispricing arises and active investors can
exploit passive investors.

[https://blogs.cfainstitute.org/investor/2016/02/02/active-
in...](https://blogs.cfainstitute.org/investor/2016/02/02/active-investing-
really-the-losers-game/)

~~~
inthewoods
First question - "they reduce liquidity" \- how?

Second, I don't think anyone is arguing that active investing can beat
potentially beat passive investing.

The problems with active management vs. passive are: \- Most active manager
will continue to underperform (this year I believe it was north of 90%) \-
That it is just about impossible to predict which funds will be leaders \-
That the fees active managers require are too high relative to the lack of any
real value

The point of the article isn't that active management can't ever beat passive
- it's that the fees on investing are coming down because most active
management provides little value.

So if active management is going to win, the fees may be compressed and that
may change the industry.

------
lordnacho
Hedge fund guy here.

There's an implicit assumption that return profile is what matters to the
investor. It very often isn't. Quite often it's a simple cover-your-ass
requirement. Gotta put my money somewhere, so anyone who isn't going to
embarrass me is fine. Thus status quo.

Second, strategies do exist that barely lose money ever. I've a friend who
runs a strategy that has had 4 losing months out of 100. Certified by a fund
administrator. Sounds too good to be true, so the fund stays small. Everyone's
heard of negative skew so they stay away.

There's also strategies that print money so regularly they don't need outside
investment. You would be amazed at how simple it is. But I've actually
reproduced this myself. You need some good execution to do it, but once it's
up you don't need or want investors. If you get a bond like income stream, you
might as well finance it like a bond. It's only stuff with low Sharpe where
you need to share the risk.

So what do you see then? A bunch of traditional managers doing their stock
picking where the result doesn't matter too much, and some funds with some
alpha that isn't stable.

~~~
crnt2
There are strategies that rarely lose money and have a great risk-adjusted
profile. But they are generally at least one of

a) Not scalable (e.g. most intraday market-making or scalping strategies)

b) Only available at a very high fee (think north of 3/30)

c) Not available at any price (e.g. Renaissance Medallion, which has been
closed to outside investors for 20+ years)

So I'm not sure that it's particularly relevant to this discussion, which is
about fee pressure on traditional, long-only asset managers.

~~~
542458
> Renaissance Medallion

[https://en.wikipedia.org/wiki/Renaissance_Technologies#Medal...](https://en.wikipedia.org/wiki/Renaissance_Technologies#Medallion_Fund)

> "From 2001 through 2013, the fund’s worst year was a 21 percent gain, after
> subtracting fees. Medallion reaped a 98.2 percent gain in 2008, the year the
> Standard & Poor’s 500 Index lost 38.5 percent."

Holy cow, that thing is kinda crazy. There has to be a catch, right? (Or
everybody would be doing it.) Or is their algorithm genuinely so clever that
nobody else has ever figured it out?

~~~
bradleyjg
They were (one of?) the first serious quant fund, started by James Simon who
before that was a math professor at Stony Brook. Along with the NSA they are
one of the most aggressive non-academic would be employers of top notch math
Phds. They also hire Phds in physics and statistics. The big draw isn't so
much the salary as the ability to invest in Medallion.

If you take some of the smartest people in the world and have them intensely
focus on making money via trading you get Renaissance. Everyone can't do it
because there are only so many some of the smartest people in the world
intensely interested in making money via trading to go around.

~~~
nswanberg
A side-note on the smart people: Nick Patterson, a cold-war cryptologist who
had worked at Renaissance for a few years, talked a little about how they had
employed some very smart people doing some very basic things like simple
regression, and that the people needed to be smart to know how to apply these
tools properly, and ensure the data they were applying it on was good.

[http://www.thetalkingmachines.com/blog/2016/2/26/ai-
safety-a...](http://www.thetalkingmachines.com/blog/2016/2/26/ai-safety-and-
the-legacy-of-bletchley-park)

------
nickff
The article is describing something that Eugene Fama (winner of the prize for
economics in the memory of Alfred Nobel,) described in a paper a few years ago
(2010).[1] Fama and his co-author French found that there is no evidence that
any active managers of mutual funds (or any other portfolio of exchange-traded
equities) have above-average skill; as a result, some will perform better than
the market, and others will perform worse, but none will predictably or
reliably outperform the average, and they each take some fee. What this means
is that since they all have about the same expected return, and have an
expected outcome of under-performing the market by the amount of their fees
(as those are subtracted from their expected average returns), you should
simply invest in a portfolio with low transaction costs and low holding costs.

[1]
[https://faculty.chicagobooth.edu/john.cochrane/teaching/3515...](https://faculty.chicagobooth.edu/john.cochrane/teaching/35150_advanced_investments/Luck%20versus%20Skilll%20in%20the%20Cross%20Section%20of%20Mutual%20Fund%20Returns.pdf)

~~~
dsacco
_> > Fama and his co-author French found that there is no evidence of active
fund managers who perform better than average..._

The paper you linked by Fama and French doesn't support this assertion. In
fact, it's incorrect, and the paper admits that there are outliers (however
few) with consistent superior performance.

From 1994 to 2014, Renaissance Technologies averaged a 71% return. From 1982
to 2012, Baupost averaged a 19% return. In the same time period the S&P 500
returned 7-8%. Even after fees, these managers easily beat the average for
their clients.

It's tempting to claim that there is no such thing as beating the market,
especially if that belief aligns well with a corresponding set of political
beliefs about Wall St. But it is inarguable that funds and managers like these
exist, it's just a matter of admitting that it's extraordinarily difficult
instead of impossible.

~~~
tempestn
No, it's not "inarguable". What the paper says is that some funds in the
extreme right tail are able to demonstrate a modicum of skill, meaning they do
better than pure randomness would suggest. However, they do not do
sufficiently better to consistently generate four-factor alpha net of fees. In
other words, they do not do sufficiently better that you could invest in one
and have a higher expected return than you would get investing in a passive
fund with similar factor exposure.

The bare fact that certain funds or managers have averaged 20%+ over whatever
time period is irrelevant, as that is absolutely expected due to randomness
alone. It has no predictive power over the ability of those funds to generate
future alpha, regardless of what intuition suggests. Again, in other words,
investing in a fund that has consistently outperformed _in the past_ does not
increase your expectation of outperforming in the future. In fact, it is more
likely than not that you will still underperform a low-cost passive fund with
the same factor exposure.

~~~
erichocean
> _Again, in other words, investing in a fund that has consistently
> outperformed in the past does not increase your expectation of outperforming
> in the future._

So…you're saying that Bayesian updating in this case does not apply? _No_
amount of positive results should alter the probabilities…ever?

(I'm not challenging your assertion by the way, just trying to confirm for
myself.)

~~~
tempestn
Sorry, no, I'm saying that historical returns have not demonstrated an ability
by anyone to consistently generate alpha net of fees. Even the longest running
market-beaters thus far do not fall far outside the expected range. Some have
demonstrated statistically significant alpha, just not enough to account for
their fees. In one sense it is certainly possible to imagine a string of
returns that would do so, but it hasn't happened yet. (Also if you believe in
(relatively) efficient markets, it seems unlikely to happen in the future
either, at least in a fashion that could be identified ex ante, and thus
profited from. But that's tangential to the point I was making above.)

The paper demonstrates this by comparing the actual distribution of returns to
many sets of simulated returns over the same period. When the simulations are
built assuming that fund managers have just enough skill to generate zero net
alpha, the actual distribution has consistently lower returns across the board
than the majority of the simulated distributions. It gets closer in the very
extreme right tail (the 98th to 100th percentiles), but still not enough to
generate positive four-factor alpha net of fees.

~~~
erichocean
Thanks, that makes sense.

------
phelmig
John C. Bogle, the founder of Vanguard (mentioned in the article) wrote a book
called "The battle for the soul of capitalism" [1] where he describes his
motivation to found Vanguard. In summary he sees that funds managers add
little value but extract too much money from risk takers (=investors) and
thereby turn capitalism up side down. Sounds like his thesis is winning.

[1] [http://www.amazon.com/Battle-Soul-Capitalism-John-
Bogle/dp/0...](http://www.amazon.com/Battle-Soul-Capitalism-John-
Bogle/dp/0300119712)

~~~
aczerepinski
Neither mutual funds nor hedge funds as a whole can match a low fee index like
Vanguard. Of course there are individual outliers that outperform, but
predicting which funds will win in the future is no easier than picking
individual securities that will win in the future.

It's becoming pretty clear that Buffett will win his 10-year bet that the
Vanguard would beat what Protege Partners thought were the five best hedge
funds.

[http://www.cnbc.com/2016/02/16/warren-buffett-slips-but-
stil...](http://www.cnbc.com/2016/02/16/warren-buffett-slips-but-still-
winning-epic-hedge-fund-bet.html)

How many hundreds of millions will those five funds have earned for themselves
while not beating the market?

------
HappyTypist
The article describes the paradox. The average fund manager will perform as
well as the market, but they charge fees so the net return is less.

If you think you are able to pick out better fund managers, then you should be
picking stocks instead. If you're unable to pick stocks, what makes you think
you're able to pick managers when you are working off opaque trades and even
less information?

~~~
bambax
I'm not defending asset managers but your argument sounds specious: you only
need to pick an asset manager once, whereas you need to pick stocks every day
or several times a day.

I can't fix my car but I can pick a garage based on reviews, etc.

~~~
nostrademons
You only need to pick a stock once too. Or at most, once per several years. If
you're trading stocks every day you're doing it wrong.

And you have a lot more information available about stocks than you do about
fund managers.

~~~
TheLogothete
Are you serious? You need a PORTFOLIO of stocks. It is an ONGOING effort.

~~~
nostrademons
You need an _information advantage_ to pick stocks. You need to have some
reason to believe you have information that the rest of the market does not
(or that the rest of the market is ignoring), which lets you better estimate
the future profits of the company. And then you compare that against the
market price, and if the market is being irrational, trade.

If you have this, you can get by with a very small portfolio, often just a
handful of stocks. And the only ongoing effort is to periodically re-evaluate
whether the market has caught on to the information advantage that you're
trading on. You do need to continue to keep informed, but daily trading is
ridiculous.

If you do not have this, you will lose your shirt regardless of how much you
diversify.

~~~
TheLogothete
>You need an information advantage

Yeah, exactly my point. You need to spend >20 hours to research a single
company and will chose to invest in 1 out of 10. Those are the optimistic
numbers.

So 5 stocks is 1000 hours. How many hours to learn how to do your due
diligence? How many hours per month, every month to keep an eye on what is
going on and optimize if necessary?

~~~
jyu
The information advantage is when you know something that's true that most
people haven't yet realized to be true, often accredited to Peter Thiel.
Examples from the past:

\- Smartphones > dumb phones (invest in AAPL)

\- more dollars spent with online ads than TV and Print (invest in GOOG)

\- cloud computing is better than managing your own servers (invest in AMZN)

\- eating Chipotle is a better option than McDonalds (invest in CMG)

These information advantages are not necessarily gained by spending many hours
of research, but a side effect from every day living and working. Will a
research analyst realize the impact of a scalable computing API more than
engineers that relies on it for their careers?

A future example: If you're a programmer using Github for every job in the
past 10 years, maybe buying Github stock if it IPO's wouldn't be so bad.

~~~
forgetsusername
> _often accredited to Peter Thiel_

Only in Silicon Valley would people give Peter Thiel credit for an concept
that's been around for 150 years of investing.

> _maybe buying Github stock if it IPO 's wouldn't be so bad._

Maybe? That doesn't sound very certain, and demonstrates how difficult it is
to pick these things _in advance_. Do you know, or not?

I mean, it's all well and good to look back at some ideas that were good
investments, in hindsight. Do you not think armies of people are trying to
find "good" ideas that no one knows about? How many good ideas went nowhere?

~~~
jerf
"Maybe? That doesn't sound very certain, and demonstrates how difficult it is
to pick these things in advance. Do you know, or not?"

Without a hypothetical IPO price, that question is unanswerable.

I honestly still agree with your general point, but that's not specifically a
valid argument.

------
paulpauper
Historically, consumer staples have much better risk-adjusted returns than any
other sector. Buying and holding these stocks will beat active management and
the S&P 500.

Active management, despite their access to expensive Bloomberg terminals and
other financial resources, by in large, are just as clueless as retail
investors, but they have more money and make up the difference in fees.

What does this prove? The fact that billionaires and hedge fund mangers – who
have access unlimited data, who can buyout seats on the board of directors,
and can even influence the news – are unable to beat the market but instead
underperform it substantially, douses cold water on the popular belief that
the markets are rigged, inefficient, or a scam. The biggest scam are these
firms charging high fees for poor performance, but the market itself is not
broken.

Instead, the market has become more efficient than ever, benefiting index
buyers and hurting those who think the are the next Warren Buffet.

~~~
TheOtherHobbes
Your points are contradictory. If consumer staples regularly outperform other
market sectors, markets can't possibly be efficient. If they were, there would
no signal to extract from the noise.

The whole idea that markets are "efficient" is specious nonsense anyway. If
they were, they'd simply be a perfect random number generator.

In fact billionaires do regularly outperform the market. Bill Gates has made
far more money from investing than he did from Microsoft.

~~~
paulpauper
and some billionaire fortunes have been lost; in the end, you get the overall
market performance. Maybe there is some excess. It would be interesting if
there were a study about if stocks of companies by Forbes 400 members
outperform stocks which don't have members.

I said more efficient than ever. That doesn't mean 100% efficiency.

------
todayiamme
>>> Technology also means that the strategies of active managers can be
replicated at much lower cost. Take value managers, who claim to be able to
beat the market by picking cheap shares. A computer program can comb the
market for stocks that look cheap relative to their profits, asset values, or
dividends; investors have no need to worry that the active manager might lose
focus or change style. When it comes to choosing between asset markets, robo-
advisers, using computer models, can help investors manage their wealth for a
very low fee. Earlier this month Goldman Sachs, a big bank, became the latest
big financial firm to buy one. <<<

There is absolutely no doubt that an algorithm can outperform most asset
managers using traditional strategies quite well, but their implied thesis is
wrong. It is extremely unlikely that any system short of an AGI, no matter how
sophisticated, will be able to displace _all_ active managers.

The reason behind that is that the best active managers try to build up
positions by creating an informational edge. The very best ones are willing to
do whatever it takes. Some have specialists analysing satellite imagery.
Others are willing to snap up equity in private competitors of a company to
check out their orderbook to predict the reality of the market before it can
be reflected by the market. Or fund studies and do their own work. Whatever it
takes.

A really great example of this trend is the rise of activist hedge funds which
work by shorting the market and exposing malfeasance at companies. Last year
an activist hedge fund manager, Whitney Tilson, found out that the products of
Lumber Liquidators was laced with a carcinogen. He had lab tests conducted,
shorted the stock, announced his results publicly, and created a media
campaign around it resulting in a tumble.
[http://seekingalpha.com/article/3019166-lumber-
liquidators-i...](http://seekingalpha.com/article/3019166-lumber-liquidators-
is-evil)

It is extremely unlikely that any system could have replicated Tilson's work,
because none of this data was online or existed somewhere that could be easily
queried. At best these systems can trade far more effectively humans can with
existing strategies, but that does not mean they can produce great returns, as
they're operating upon the information the market already knows, as opposed to
seeking out what isn't known.

There are similar examples within commodities - there are firms that
specialise in using satellite imagery to predict if OPEC has increased
production or what the global yield of rice / wheat is going to be. (case in
point
[http://www.bloomberg.com/news/features/2015-07-08/satellite-...](http://www.bloomberg.com/news/features/2015-07-08/satellite-
images-show-economies-growing-and-shrinking-in-real-time) ) There is an arms
race going on right now to know what the state of any economy will be before
anyone else knows it. They will continue to specialise along this route by
funding remote sensing companies, putting money into internet analytics to
predict future usage patterns, and everything else they can think of before
anyone else.

Machines just can't compete - at least, for now.

~~~
jdoliner
Really cool point.

I'd argue that the investment strategies you're describing are actually
creating value. Getting information about carcinogens out into the world is a
plus for sure. Another instance of this is Herbalife which is looking more and
more like a Ponzi scheme thanks to an activist investor.

Welcome to the era of regulation through speculation.

~~~
hkmurakami
Just FYI your Herbalife info is out of date, as it has experienced a massive
rally as of late.

Imo I believe John Hempton's take on Herbalife, which is that what they sell
is not the supplement but a "sense of community" that the participants
strongly desire.

------
iofj
The article's basic assumptions are wrong. Money is flowing out of private
investment, so they just assume it's flowing into index funds. However ...
Index funds doesn't seem to be where it's going.

SPY lost 15% or more in Feb, and then recovered to only be down 5.5%. Before
that a similar thing happened around new year. The trend appears to be down
(in the sense that the second massive drop fell to a lower level than the
first, and doesn't appear to be recovering the level the first recovered to),
and a lot of banks are saying that people should sell the recovery. And if you
prefer non-technical arguments : stocks in the S&P 500 are trading at a GAAP
EPS multiple of ~21. Whilst that is actually a bit of a drop from before,
that's still a >98% percentile for the multiple. "Normal" multiple is 16,
which would have the S&P 500 trading at ~1550, and generally if you believe in
mean reversal you'd expect it to drop below that before improving.
Additionally the fed is raising rates, and that has always resulted in stock
market drops. And all of this is assuming there isn't something more serious
happening (global shipping has dropped double digit percentages since last
year, which would seem to indicate a very serious issue, especially in Asia).

I'm thinking there is a general outflow out of the stock market entirely.
Index funds and everything. I would even bet that private investments are
dropping, partly because quite a bit of investment advisors are telling people
to get out of the market.

------
ssharp
If you have a consumer facing service and you charge on a commission basis,
the tide is turning for you.

Asset managers can just get added to a list that already includes positions
like real estate agents, insurance agents, car salespersons, etc.

The problem is the inability for these people to continue to provide value
against alternatives that justifies taking a commission.

I don't think there's a line in the sand for when these jobs become obsolete
but the slow crawl towards it has been happening for a while.

~~~
eldavido
Two important factors you're leaving out:

(1) Does the intermediary add value? Sometimes they do, by facilitating better
market functioning. If I sell a house and a real estate agent has access to a
better buyer pool than I do -- likely, as they've been doing it for a while --
then I benefit with a higher selling price and the agent gets a commission.
The loser is the "deal hunter" buyer who sits at the low end of the market,
looking for a "deal" due to something being mispriced.

In some markets, e.g. public market trading and low-end insurance, it's easy
to get the same benefits with a computer. On the higher end, however, like
with complex business insurance, I'd gladly pay a middleman a few % to help me
get through the complexity of picking out the right package, coverage, helping
me think through the risks, etc.

(2) Are people afraid of doing it themselves? When dealing with a large enough
proportion of wealth, some people will demand assistance, even if very
expensive. I see this dynamic all the time in real estate. Most people don't
want the hassle of selling a house themselves and would rather, somewhat
lazily, just have someone else deal with it.

------
jdonaldson
The return profile is not the end-all-be-all for an investment. There's
different strategies for tax avoidance, income generation, and for handling
inheritance situations.

Most folks here are clever enough to work these out on their own, but the
question is whether or not it's worth it for them to do so if a small portion
of that money can pay someone to do it for them.

------
pkulak
Great podcast on this recently:

[http://www.npr.org/sections/money/2016/03/04/469247400/episo...](http://www.npr.org/sections/money/2016/03/04/469247400/episode-688-brilliant-
vs-boring)

------
lifeisstillgood
This may be a dumb question; but as I am looking for my next project, what is
so hard about setting up a robo-adviser firm?

Algorithm A : put $AGE % of funds into treasury bonds, put 85-$AGE % into
index firm / ETF

Algorithm B: err?

~~~
crnt2
The difficult part is getting regulated, and raising money.

Robo-advisers are subject to the same regulation as traditional asset managers
- a regulatory burden which is only likely to increase over time. The legal
fees associated with regulation are not cheap.

Compounding the problem, a competitive robo-adviser needs to offer lower fees
than a traditional asset manager. Probably they need to be in the 0.25-0.5%
range, which means that for each $1m under management they are picking up
$5,000 of revenue. Out of that they need to pay salaries, infrastructure
costs, legal costs, rent, taxes etc. Let's be conservative and say that these
costs are $2.5m per year. That means that a robo-advisor needs about $0.5bn
under management before it begins to turn a profit.

I don't think it's really suitable as a side project.

~~~
justincormack
You could just start with a free open source product. Far more disruptive. You
could launch it offshore and unregulated if you want to cut costs.

~~~
gaius
It depends on whether you want to "disrupt" or to earn a living yourself.

------
Dowwie
and to add insult to injury, investment managers are expected to pursue
advanced designations such as the CFA, which takes years of hard work --
hundreds of hours of intense study and preparation

perhaps the standards settings bodies such as the CFA Institute should share
some of the responsibility

------
xyzzy4
All you have to do to make tons of money is buy UPRO (s&p 500 leveraged 3x)
and sell it when the economy is at high risk of recession. If you chart it out
historically since 60 years back it would make a fortune.

~~~
btian
All you have to do to make tons of money is buy whatever stock that will rise
by the most next week, and short sell stock that will tank the most next week.

How to find out which stock will rise or tank next week is left as an exercise
for the reader.

