There are powerful psychological reasons why people want to believe City experts can beat the market but one function of the bursting of a bubble is to destroy such illusions. The active fund management industry will be one of the victims, making its slow death one of the predictable outcomes of the 2008-09 Crash.
When so-called cautious funds can fall by 25 per cent in a few months and even “well diversified” portfolios show 20-30 per cent losses, even the most naïve of investors will surely ask how much faith they should place in all those experts and advisers.
We are already seeing people wheel out the conventional defence – the 2008-09 Crash was a one-off, once-in-a-lifetime event and normal service will shortly be resumed. I still work in the City and this is the third such event in my working life and I could easily count other crises apart from 1974 and 1987 that were also classed as once-in-a-lifetime when they happened. The Crash of 2008-09 is not a one-off. Risk is a bigger and nastier beast than conventional models assume.
We already know that active fund management is fool’s gold. The evidence of the rigorous scrutiny of fund management by academics is conclusive – long-only active fund management cannot beat the market with sufficient reliability or predictability to be worthwhile for the average investor.
You don’t have to subscribe to the strong version of this proposition to conclude that most fund managers sell to greed and that most advisers make greed palatable by wrapping it in the safety blanket of diversification. That this is a bull market strategy becomes obvious when the tide goes out and we see who really was swimming naked – in this case, the entire active fund management industry.
You can disregard the industry’s failings if you like and argue that investor amnesia will enable it to stagger on but that won’t save fund managers. The reason why active fund management will die is demographic. The boomer generation is moving into decumulation. Following generations are not generating capital at the same rate and never will. The active fund industry’s customers are a dying breed.
If the next generation could be counted on to buy more conventional funds, there would be some grounds for optimism. But they won’t. The investors who have opened hundreds of thousands of new online sharedealing accounts in recent years are buying exchange traded funds rather than conventional funds. They can see it is better to pay an annual charge of 0.5 per cent than one of 1.75 per cent.
It is the reduction in annual fees that will kill active fund management. Managers hope they can generate enough belief in new black boxes like absolute return strategies to justify high fees but the wheels have already come off some of these supposedly all-terrain vehicles. And don’t we have to ask, if these clever strategies are worth 1.5 per cent a year, surely a long-only fund should charge less?
The active fund management industry needs to downsize. Substantially. A huge wave of consolidation and mergers is required to reduce overcapacity. But defensive mergers do not often add value, they just reduce the pace at which value is being eroded. A stable share of a shrinking pot will be the best many can hope for… I’m a celebrity fund manager, get me out of here!
The old model involved the placement of lots of capital in funds with expense ratios of 1.5 per cent a year or more.
The features of most new models will be a lower proportion in risk assets, and a significant proportion of that risk capital going into low-cost quant funds or structured products. There’s not much gold in these hills.
You need a heroic degree of faith in investors’ willingness to be fooled again to regard listed fund management businesses as good long-term investments. New Star won’t be the last victim of the grim reaper.
Chris Gilchrist is director of Churchill Investments and editor of The IRS Report
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