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The money doctors In many industries firms avoid price competition by offering a
product distinct from their rivals—or, at least, that appears
distinctive. Breakfast cereal is mostly grain and sugar, but makers
IN MARCH 1868 a prospectus appeared for a new kind of offer a proliferation of branded cereals, with subtle variations on
money-market scheme. The Foreign & Colonial Government a theme. Asset management is not so different. Firms compete in
Trust would invest £1m ($5m at the time) in a selection of bonds. marketing, in dreaming up new products and, above all, on their
For £85 an investor could buy one of 11,765 certificates giving an skill in selecting securities that will rise in value.
equal share. The trust promised a 7% yield. Its aim was to give
“the investor of moderate means the same advantages as the The industry has not performed well. Ever since a landmark
large capitalist in diminishing the risk of investing…by spreading paper by Michael Jensen in 1968, countless studies have shown
the investment over a number of different stocks.” The modern that managers of equity mutual funds have failed to beat the
asset-management industry was born. market index. Arithmetic is against them. It is as impossible for all
investors to have an above-average return as for everyone to be
A week later The Economist ran a leading article broadly
of above-average height or intelligence. In any year, some will do
welcoming the new trust. But—setting the tone for 150 years of
better than the index and some worse. But evidence of sustained
financial punditry—it quibbled about the selected bonds. A chunk
outperformance is vanishingly rare. Where it exists, it suggests
was allocated to Turkey and Egypt, countries that “will go on
that bad performers stay bad. It is hard to find a positive link
borrowing as long as they can, and when they cease to borrow,
between high fees and performance. Quite the opposite: one
they will also cease to pay interest.” Fears were expressed that
study found that the worst-performing funds charge the most.
Europe was disintegrating. “In lending to Italy, you lend to an
inchoate state; and in lending to Austria, you lend to a Why do investors put up with this? One explanation is that
‘dishevelled’ state; in both there is danger.” investment funds are more complex than breakfast cereals. At
best they are an “experience good” whose quality can be judged
The trust was the brainchild of Philip Rose, a lawyer and financial
only once consumed. But they are also like college education or
adviser to Benjamin Disraeli. His idea of a pooled investment fund
medical practice: “credence goods” that buyers find hard to
for the middle class caught on. In 1873 Robert Fleming, a
judge immediately. Even well-informed investors find it tricky to
Dundee-based businessman, started his own investment trust,
distinguish a good stockpicker from a lucky one. Savers are keen
the First Scottish, modelled on Rose’s fund but with a bolder
to invest in the latest “hot” funds. But studies by Erik Sirri and
remit. It was largely invested in mortgage bonds of railroads
Peter Tufano in the 1990s show that, once fund managers have
listed in New York. The holdings were in dollars, not sterling. And
gathered assets, those assets tend to be sticky. They are lost only
whereas Rose’s trust was a buy-and-hold vehicle, the trustees of slowly through bad performance.
the First Scottish reserved the right to add or drop securities as
they saw fit. Firms have a fiduciary duty to act in the best interest of
customers. Securities regulators (eg, the Financial Conduct
Rose’s trust survives to this day, but asset management is now a
Authority (FCA) in Britain and the Securities and Exchange
far bigger business. Over $100trn-worth of assets is held in Commission (SEC) in America) oversee asset managers. Unlike
pooled investments managed by professionals who charge fees.
banks, which borrow from depositors and markets, asset
The industry is central to capitalism. Asset managers support managers are unleveraged and so not subject to intensive rules.
jobs and growth by directing capital to businesses they judge to The assets belong to beneficial investors; they are not held on a
have the best prospects. The returns help ordinary savers to firm’s balance-sheet. The thrust of regulation is consumer
reach their financial goals—retirement, education and so on. So protection from fraud and conflicts of interest. It does not
asset management also has a crucial social role, acting as
prescribe investment strategies or fees. An investigation by the
guardian of savings and steward of firms those savings are FCA in 2016 found that investors make ill-informed choices,
entrusted to.
partly because charges are unclear. The problem of poor
decision-making is most acute for retail investors. But even some
It is a business unlike any other. Managers charge a fixed fee on
institutional investors, notably those in charge of small pension
the assets they manage, but customers ultimately bear the full
schemes, are not very savvy. Around 30% of pension funds
costs of investments that sour. Profit margins in asset
responding to a survey by the FCA required no qualifications or
management are high by the standards of other industries. For all
experience for pension trustees. Investors are a long way from
the talk of pressure on fees, typical operating margins are well
the all-knowing paragons of textbook finance theory.
over 30%. Yet despite recent consolidation, asset management is
a fragmented industry, with no obvious exploitation of market
Medical manners
power by a few large firms and plenty of new entrants.
A paper in 2015 by Nicola Gennaioli, Andrei Shleifer and Robert The steady decline of long-term rates is a nightmare for pension
Vishny argued that fund managers act as “Money Doctors”. Most funds, because it increases the present value of future pension
people have little idea how to invest, just as they have little idea promises. Industry bigwigs often blame the Federal Reserve and
how to treat health problems. A lot of advice doctors give is other central banks. But interest rates have been falling steadily
generic and self-serving, but patients still value it. The money since the 1980s. There are deeper forces at work. The real rate of
doctors are in the same hand-holding business. Their job is to return is in theory decided by the balance of supply and demand
give people the confidence to take on investment risk. for savings. The balance has shifted, creating a bonanza for asset
managers, whose fees are based on asset values.
In asset management, as in medicine, manner and confidence are
as important as efficacy. “Just as many patients trust their doctor, There are competing explanations for the savings glut.
and do not want to go to a random doctor even if equally Demography is one: people are living longer, but average
qualified, investors trust their financial advisers and managers,” working life has not changed much. More money must be salted
say Mr Shleifer and his co-authors. This may explain why away to pay for retirement, with much of the saving taking place
investors stick with mutual-fund managers even in the face of in the years of peak earnings in middle age. A bulge in the size of
only so-so performance. As long as asset prices go up, a rising the middle-age cohort has pushed the supply of savings up.
tide lifts most boats in the asset-management industry—including Another factor is the growth of China and other high-saving
a lot of leaky vessels. emerging markets. At the same time, the demand for savings has
fallen. When Robert Fleming set up his investment trust,
But the seas are getting rougher. Over the past decade, investors enterprises like railways were capital-intensive. Today the value of
have placed more capital with low-fee “passive” funds. These firms lies more in ideas than in fixed capital. Big companies are
funds invest in publicly listed stocks or bonds that are liquid— self-financing. Small ones need less capital to start and grow. The
that is, easy to buy or sell. The most popular are “index” funds, upshot is that more money is chasing fewer opportunities.
run by computers, that track benchmark stock and bond indices. Investors are responding by trying to keep fund-management
The industry’s big winners have been indexing giants whose scale costs down and putting more money into private markets in
keeps costs down and fees low. The two largest, BlackRock and hopes of higher returns than in public markets. This response is
Vanguard, had combined assets under management of $13.5trn reshaping the asset-management business.
by the end of 2019. The losers were active managers that try to
pick the best stocks. This special report will consider the outlook for the industry and
ask what it means for the economy, for the stewardship of firms,
High fees have not disappeared. The boom in passive investing for capital allocation and for savers who place their trust in the
has spawned its antithesis: niche firms, run by humans, in thinly money doctors. It will examine whether China’s untapped market
traded assets charging high fees. A growing share of assets can be a source of renewed growth. A good place to start is with
allocated by big pension funds, endowments and sovereign- the forces shaping the industry’s elite.■
wealth funds is going into privately traded assets such as private
equity, property, infrastructure and venture capital. What has Asset Management the money doctors
spurred this shift is a desperate search for higher returns. The
management of private assets is an industry for boutiques rather The money doctors
than behemoths. But it has its own big names. A quartet of Wall
Passive attack
Street firms—Apollo, Blackstone, Carlyle and KKR—have
captured much of the growth in assets allocated to private Double trouble
markets.
Stewards’ inquiry
The shake-up in asset management owes a lot to
Taking back control
macroeconomics. The investors who snapped up certificates in
Rose’s trust were dissatisfied with 2% interest in the money Frogs and princes
markets. Today investors would sell their grandmothers for such
a yield. Interest rates in parts of the rich world are negative. In The Shanghai Open
Germany and Switzerland, government-bond yields are below
Doctor’s prescriptions
zero across the curve, from overnight to 30 years. Inflation is
absent, so ultra-low interest rates are likely to persist. The This article appeared in the Special report section of the print
expected returns on other assets—the yields on corporate bonds, edition under the headline “The money doctors”
the earnings yields on equities, the rental yield on commercial
property—have accordingly been pulled down. The value of https://www.economist.com/special-report/2020/11/12/the-
assets in general has been raised. money-doctors