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Decline and fall of fund firms

An industry that is incapable of delivering what it promises can only survive through a collective suspension of disbelief by its customers.

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

The individual who posts the best response to this article (as judged by the editor) in the next week will win a 6-monthly subscription worth £65 to the newsletter Chris edits,The IRS Report.


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There are 5 comments at the moment, we would love to hear your opinion too.

  1. Andrew Wilkinson 26th October 2009 at 6:42 pm

    A slow death ??? Yes and no. Yes because people have been ripped off by fund managers for years who in turn have been supported by the regulator. Yes because its already been happening for years. Isnt it the case that disillusionment with the tradtional fund management industry was responsible for for the great bull UK property of the last 10 years???? And the great refusal of the FSA to issue any significant guidance as the exodus took place???? Creating the great irony that the regulated were only able to advise on the products that investors were pretty sure didnt really work, leaving the unregulated free to run roit and the ‘investor’ with no protection as all???
    No – because the whole system is based on the financial interests of the biggest companies. And so they and their interests will persist.
    Perhaps our super regulator be renamed

  2. Chris is on a win win here – one fine day in 2086 soemone will re read this prophecy and say what an amazing foreseight Chris Gilchrist possessed – now whether it is 10 20 or 50years from now that this prediction will come true I have no idea – I suspect Chris is suggesting the next 5 years – and in this he is completley wrong. Joe Public generally has never bought a product based on the AMC in fact in my 30+ years in the industry I have never had anyone queue up to buy Pension Savings or Life Assurance – As Chris intimates that demographichs is the big issue facing fund managers because of the ‘decumulation of boomers’ I would argue we have at the very least another 15 years of massive Boomer wealth and accumulation through Boomer parents estates and Boomer pensions funds pouring into the Boomer pockets – do these clever Boomers go online and open a Schwab account or buy an ETF – no chance – they have probably no idea what an ETF is – because advisers will not tell them and because adviers will continue to sell funds with trails – it is the major IFA business model (witness the continued growth of SIPPs & Fund Platforms) – Funds under mgt = trails = value = strategic exit plan. So Chris until you can persuade an IFA to sell a product with a 0.5 AMC and no reward for the IFA then forget your hypothesis – lie back and think of stakeholder before you jump to false conclusions. We are like sheep and lemmings we do as we are told.

  3. Whether (some?) active fund managers add value is a question that may never be conclusively answered. The one thing we can be certain of is that there is no point in paying more than 0.5% for ‘closet tracker’.

  4. Why do you keep pushing this man’s articles?What so good about him and his opinions – not interested.

  5. The assertion that the active managed fund industry will die is I think wrong, however I totally agree with the rest of the article particularly in terms of the willingness of clients to pay the exorbitant fees associated with most active funds (most of which will never have been disclosed to themin the TER!). The reason that clients will start to question fees is simply because most IFAs will, for the first time, have to start telling their clients what they themselves are charging for their advice and the natural consequence of this is that the clients will ask what other charges they face. How do you think a client with a £250k portfolio will react when you tell him that you are charging him 1%, the platform/wrap is charging 0.3% and the fund manger TER is around 1.7% (even after deduction of trail and not including dealing costs or underlying fund costs in the case of FoFs)? 3.0% of £250,000 = £7,500 per annum with a 70% chance that his fund manager will not beat the chosen benchmark. Would you accept those terms? Believe me If clients don’t know about ETFs yet, it will not take them long to find out that by using them extensively they could reduce that annual fee by half and have an improved chance of at least matching the chosen benchmark.

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