Who Took the Fun Out of Fund Management?

(Bloomberg Gadfly) -- "Happy families are all alike; each unhappy family is unhappy in its own way," was how Leo Tolstoy started his novel Anna Karenina. The three tribes that make up the asset management business are each suffering their own crisis of confidence -- and none of them has anything to do with Brexit.

In the past fortnight, I've attended a trio of separate seminars in London on the future of hedge funds, the future of exchange-traded funds, and the future of asset management. All three had a palpable undercurrent of anxiety about what tomorrow will bring.

On the face of it, the ETF bash should have been the most angst-free of the gatherings. Index trackers and their ultra-low fees continue to attract mindboggling amounts of cash around the world. But in a day of discussions at the Waldorf Hilton hotel last week, one concern stood out.

Who Took the Fun Out of Fund Management?

What worries the ETF practitioners isn't the accusation that passive investing is worse than Marxism, or the charge that it's in danger of devouring capitalism. Their anxiety is focused on ETFs tied to the fixed-income market -- specifically, what will happen to values if the corporate bond market pukes.

The two regulators at the ETF conference -- Robert Taylor, head of global asset management regulatory strategy at the Financial Conduct Authority, and Martin Moloney, special advisor on policy and risk at the Irish central bank -- both cited fixed-income ETFs as the most troubling market sector. Their specific disquiet is that investors haven't been fully appraised of the particular risks of corporate bonds.

The credit market doesn't offer anything like the liquidity of the stock market -- something investors trying to offload fixed-income ETFs in the midst of a plunging market may discover to their cost. The prospect of ETFs trading at deep discounts to their net asset values worries regulators and market participants alike.

"ETFs are only as liquid as the underlying asset," was the mantra repeated by several speakers at the conference. That's true. But it could prove a flimsy defense if, in the event of a swift collapse, illiquidity leaves fixed-income ETF values slumping more quickly than the underlying market.

In active management, the switch to low-cost passive products pioneered by Vanguard Group Inc. combined with scrutiny by U.K. regulators have focused attention on just how opaque -- and costly -- the industry's fee structures are.

But fear of being "Vanguarded" is old hat by now; what's really baking the collective noodle of traditional fund managers is the prospect of Amazon.com Inc. or Apple Inc. or Alphabet Inc.'s Google starting to offer saving and retirement packages.

Investing remains the land that time forgot; largely paper-based, archaic in its language and operations, and distinctly user-unfriendly. A savvy web-based offering from a trusted brand could capture legions of youthful investors in a heartbeat; hell, Amazon could offer index-tracking products for free as part of its Amazon Prime program.

The rise of technology is also what's concerning the hedge-fund industry, although in a different guise. Artificial intelligence, machine learning and big data are creating "an arms race to add new weapons to tackle the problem," according to Luke Ellis, the chief executive officer of Man Group Plc, the world's biggest publicly traded hedge fund.

At the start of the previous decade, before the financial crisis, starting a hedge fund was relatively easy. Now, the costs associated with increased regulation make it much more expensive. The rise of the robots raises the barriers to entry even further.

The hedge-fund gang doesn't expect machines to take over; but players who can't afford access to the latest technology as collaborators won't be able to keep up. And the competition for talented programmers, data analysts and other technologically-savvy workers is only headed in one direction.

Collectively, then, the asset-management profession is undergoing something of a soul-searching time. That can only be healthy for an industry that will become ever-more important in an ageing society that needs to save for its future. Innovations such as performance-based fees can help to restore trust, better aligning the interests of investors and managers. But the days of being handsomely rewarded just for accumulating assets are over – and not before time. 

Mark Gilbert is a Bloomberg Gadfly columnist covering asset management. He previously was a Bloomberg View columnist, and prior to that the London bureau chief for Bloomberg News. He is the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”

To contact the author of this story: Mark Gilbert in London at magilbert@bloomberg.net.

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