Active fund managers face more pain — Moody’s
The investor shift from active asset management to cheaper passive strategies will accelerate in the coming years and weigh on the earnings and credit ratings of investment groups unable to adapt to the new realities of the money management industry, according to Moody’s.
The worsening ability of many fund managers to beat their benchmarks, coupled with their costs, has led to an investor exodus in favour of cheaper investment strategies such as exchange-traded funds, that seek to merely mimic the performance of a market at the cheapest possible cost.
Ongoing for over a decade, the trend has accelerated and broadened recently, and badly rattled the traditional asset management industry that controls trillions of dollars worth of savings globally. As a result many have sought to build or buy their own passive investment operations, but those that fail to adjust will increasingly struggle, Moody’s warned in a report published on Monday.
“Large traditional asset managers that lack a core competency in passive investing, or that are unable to deliver outperformance to justify their fees, are at risk of seeing their business profiles weaken further, increasing the likelihood of ratings deterioration,” the rating agency’s report said.
Academics have long shown that the average fund manager will only perform as well as the market, and underperform it after fees, but the ability to even get close to benchmarks appears to have atrophied further in recent years.
Only 18 per cent of “large cap” US fund managers – which invest in the biggest American companies – managed to beat the Russel 1000 index in the first half of 2016, according to Bank of America Merrill Lynch, the worst performance of active funds since at least 2003.
Moody’s argued that the fundamental driver of the poor performance of active asset managers is the sheer size of the industry, with over 9,000 mutual funds and 10,000 hedge funds in the US, according to the rating agency.
“Overcapacity leads to investment mediocrity, since true talent is limited and size works against the investor in the form of increased transaction costs and difficulty in identifying scalable investment opportunities,” the report said. The active asset management industry will therefore have to “shrink substantially” in the coming years to improve performance, it added.
Some big asset managers agree, and have moved to constrain fund sizes and focus more on returns. “There is a scale problem in the industry,” Peter Kraus, the chief executive of AllianceBernstein, told the FT earlier this year. “Our advice to the industry is to constrain ourselves. We are hurting ourselves by growing too big.”
Others have predicted that a wave of consolidation will sweep over the industry as a result of the current challenges, but Moody’s was more circumspect, doubting that this would be a “panacea”.
“Acquisitions do not address the root cause of active underperformance, since they do not reduce the amount of capital managed by active managers or improve the aggregate performance of the industry,” the report argued. “Instead, a fundamental rethinking of the traditional active mutual fund industry as a whole is required.”
The trend towards passive investing is particularly powerful in the US.While $21.7bn gushed out of actively managed US equity funds last month - the worst monthly figure since the depths of the financial crisis - passive funds absorbed $8.7bn.
A new rule on the fiduciary duties of investment advisors introduced by the Department of Labor this year is expected to speed up the investor shift from active to passive investment vehicles.