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Editorial

Free lunch leading to indigestion?

Nobel Prize winning economist Harry Markowitz in the 1950s called diversification "the only free lunch in finance." His pioneering work laid the foundation for understanding the nature of risk in portfolio management.

What, then, should investors make of the ongoing march toward consolidation in many aspects of institutional investment management?

Pensions & Investments' latest research in 2018 again reveals further concentration and the dominance of industry behemoths. Institutional assets are concentrated with the largest money managers, and assets managed by outsourced CIO managers are growing much faster than the market itself.

In the money manager survey P&I published in May, the three largest managers by worldwide institutional assets accounted for 20.9% of such assets under management by the 500 largest firms in P&I's universe.

Meanwhile, OCIO managers reported a 23% surge, to $1.74 trillion in assets managed worldwide for institutions with full or partial discretion, in the year ended March 31, data from P&I's latest investment outsourcing survey showed.

As with the traditional universe of asset managers, outsourced assets were concentrated within the tier of the largest managers, analysis of P&I data showed.

The 25 largest managers of worldwide institutional discretionary outsourced assets managed 89% of the $1.7 trillion of assets, while the 25 biggest managers of worldwide institutional outsourced assets held 90% of the $2.09 trillion of assets in that pool.

None of these trends can be viewed in isolation from other global economic forces. Exceptionally low interest rates have pushed managers to extend the duration of their portfolios or invest in riskier assets, notes the annual report from the Bank of International Settlements, published in June.

That potential vulnerability is further amplified, it noted, by industry consolidation. "Various structural features of the asset management industry may contribute to magnifying this vulnerability," according to the report. "One is a high concentration of assets under management, which can result in a clustering of risks within a limited number of large asset management companies."

Institutional asset owners and asset managers have pushed in recent years for greater diversity of companies' boards of directors as well as executive ranks, arguing that the corporate bottom lines benefit when a variety of opinions are considered when setting strategies.

Of course, greater scale, sophistication and access to more resources among asset and OCIO managers can undoubtedly benefit the institutional investor.

But the moves toward larger and larger pools of assets in the same hands does raise questions: Are investors losing access to the diversity of investment ideas? What will the loss of this free lunch ultimately cost?

Asset owners should feel empowered to question their managers on strategies for curbing crowd-think. Otherwise, that free lunch could turn into a meal that's not only expensive, but potentially stomach-churning, indeed.