Money managers that come through this season of scandal untarnished may get too big for their britches — or too big, in any case, to do right by their clients.
Doing right by clients is the new mantra for firms that have suddenly found themselves on investors' fiduciary dishonor roll. But the winners in the industry's ongoing shakeout face an ethical question of their own: How much client money can they take on before they compromise their ability to deliver market-beating returns?
The tradeoff between a money manager's fund inflows and its ability to deliver alpha "is a huge issue" — damaging investors far more than the market-timing revelations dominating the news recently, according to Jeremy Grantham, chairman of Boston-based Grantham, Mayo, van Otterloo & Co.
The more client money a manager accepts, the more unwieldy the mutual fund or segregated account becomes, hobbling the manager's ability to beat the market, Mr. Grantham argued. Past a certain threshold, a manager is feathering its bed at the expense of its investors, he said.
That conflict of interests is embedded in the industry's fee structure. With fees based on assets under management, managers get an immediate payoff from taking more money while the penalty, in terms of performance leakage, surfaces more slowly, said Joe Nankof, a senior consultant with Rocaton Investment Advisors LLC, Norwalk, Conn. And if a money manager excels at other aspects of client servicing, a client may well stick with that manager even if outperformance flags, Mr. Nankof said.
For mutual fund watchers, this is another issue that a fund's board of directors should handle. The management company is there to make money, but fund directors are there to care for shareholders, and they should be ready to step in and close a fund, said Ward Harris, managing director of Berkeley, Calif.-based McHenry Consulting Group.
On the institutional side of the ledger, consultants gauge the asset levels firms attempt to manage on behalf of clients as an essential part of their evaluations. Michael Rosen, principal at consultant Angeles Investment Advisers LLC, Santa Monica, Calif., said his company quizzes all managers about their capacity for investing in different asset classes, such as how big a stake they're comfortable owning as a multiple of average daily trading volume, to get a sense of their limits.
Portfolio managers play a role as well. "I know of many situations where we have business management people or sales people interested in having more money," while portfolio managers, with an eye on fiduciary responsibility and incentive-based compensation, will push back, said Mr. Nankof.
If there are checks and balances, they are inadequate to the task at hand, Mr. Grantham said.