If investors were enraged by Wall Street 80 years ago, they are enraged now. Many investors get lackluster profits after fees, while industry players become wealthy and richer. Asset management is a strange and perplexing enterprise. Here are six major indications of how unusual this business is.
According to Ray Dalio, the founder of Bridgewater Associates, Alpha is a zero-sum game. Most sectors, on the other hand, are positive-sum: just because you have a delicious steak, supper does not mean everyone else has to eat hot dogs. Each new money manager that delivers alpha (returns above the passive benchmark performance) in asset management does so at the expense of underperforming managers.
Because of changes in the value of the underlying asset and/or market preferences, the value of your own investment may vary. Except for private equity and venture capital investors with portfolio acceleration strategies, few investors may directly influence the value of the underlying asset. Celebrity investors like George Soros have the ability to sway market sentiment, but most of us do not.
In fact, beating a low-cost sector index after fees is statistically unattainable for the average investor in that area. Money managers that specialize in well-developed sectors for which indices are not easily available (e.g., private firms, frontier markets, cryptocurrencies) and/or emerging asset classes, we believe, are playing a positive-sum game.
Since 2000, hedge funds, on average, have underperformed in both U.S. stocks and bonds on a net-of-fees basis. The HFRI Index returned 18.3 percent annually over the first ten years, from 1990 to 1999, but just 3.4 percent annually for the next ten years, from 2000 to 2016. According to Morningstar’s Active/Passive Barometer, just 26.4 percent of US big cap, 22.7 percent of US small-cap, and 24.3 percent of global large-cap active equities mutual funds outperformed their passive counterparts in the five years ending October 2021.
“With improved analytics, institutional investors have concluded there are minimal alpha and that risk premium explaining a lot of the excess returns,” said Nicolas Rabener, managing director of FactorResearch.
Due to the illiquid nature of certain of the underlying investments, which gives the flexibility to manipulate pricing in advantageous ways, according to Amit Matta, a risk management specialist, performance is often exaggerated (and risk downplayed). However, a major group – corporate actors — has distinct goals. “They account for more than half of the primary market (sellers) and are significant players in the secondary market (M&A), making the markets a positive-sum game.” When they acquire a successful IPO or sell their position to a corporate buyer, all asset managers have a chance to profit.”