Nobel laureate Bob Dylan's lyrics from his 1964 release "The Times They Are a-Changin' " are words every business leader should keep in mind when planning for the future: "… the present now will later be past, the order is rapidly fadin' …"
We believe this is even truer for the active asset management industry.
Over the past years, various advancements radically changed the telecommunications, technology, aviation, medicine and auto industries, to name a few. Think of the disruption Tesla is causing to the auto industry, the revolution Apple brought to the phone market, and the rebellion Amazon.com introduced in retail. Previously established players had to adapt to compete in the new norm of things. Those who didn't, disappeared.
A wave of change is coming to the asset management industry, which at its core has not materially changed its practices, processes and approach over the past decades. Still, a portfolio manager is in control of vast amounts of assets, following investment approaches that utilize financial information that is now standardized, common and well understood by most market actors. It should not be surprising then that long-term alpha generation has become so much more difficult.
In the meantime, demand for passive strategies from asset owners and retail investors has increased substantially amid supply growth from asset managers. The growth in passive investing is justified. It came as a response to the industry becoming fat, lazy and self-serving. Standard & Poor's research finds most active managers tend to underperform their respective benchmarks over medium- and long-term horizons. At the same time, way too many products charge high management fees while quasi-indexing and seeking to minimize tracking error. According to a Harvard University study, for every dollar managed by truly actively managed funds, there are $3 in index and quasi-index funds. And the majority of asset managers are compensated as bureaucrats: a flat management fee with no performance fees in place. Interestingly, on this last front, Abigail Johnson of Fidelity Investments recently slapped the industry in the face by admitting the lack of alignment with customers by announcing the introduction of fulcrum fees.
Does that mean active management is fading out? Yes, in the form we know it today. No, for managers who will develop capabilities enabling them to understand unstructured data and take better informed decisions.
How can managers differentiate themselves and ensure they are on the winning side of the equation? There are three forces we see acting as catalysts.