Buttonwood - Living off the people

A history of investment shows how managers have prospered

Mar 5th 2016

FOR as long as there have been organised economies, people have been employed

to look after the wealth of others. More than 4,000 years ago landowners in

Akkad, an early Mesopotamian civilisation, hired local managers to look after

their farms.

In their new book, Investment: A History , Norton Reamer and Jesse Downing

explain how the industry has changed over time. Their fundamental idea is that

investment has become democratised , available to a wider range of

individuals.

Early investment was conducted on behalf of the wealthy, often by individuals

with low status current or former slaves in the Roman Republic, for example. In

the Biblical parable of the talents, a master entrusts his wealth to a range of

servants. Two of the servants doubled the master s money but the third buried

it in the ground, rather than investing it with the bankers . For this

failure, the poor performer was cast into the outer darkness where there

will be weeping and gnashing of teeth . Today s clients might welcome the

ability to add this penalty clause to their contracts.

Looking after the assets of the rich or high-net-worth individuals, as they are

known in the jargon is still big business. But the fund-management industry s

growth has been turbocharged by the evolution of a much wider client base. In

the rich world, most people have some money available for savings after they

have paid for the necessities of food, clothing and shelter. With a retirement

age of, in effect, around 65, they have two decades or so of old age to provide

for. In America, retirement savings grew from $368 billion in 1974 to more than

$22 trillion by 2014 a fivefold increase in assets relative to income.

This has transformed the industry. Investment management was once a dull

business, consisting mainly of helping trust funds stock up on government

bonds. The standard joke was: Why don t fund managers look out of the window

in the mornings? Because then they d have nothing to do in the afternoons.

Nowadays fund management is a much more glamorous profession more masters of

the universe than keepers of the paper clips.

Another key to the change in the industry s fortunes is its reward system. Fees

are linked to the value of the assets, even though the cost of managing $10

billion is little more than the cost of looking after a measly $1 billion. So

fund managers have benefited twice over: first, from the expansion of pension

and other savings and, second, from the huge rise in asset prices since the

1980s. The latter has been driven by falls in inflation and interest rates

which have reduced the yield (and thus increased the price) of financial

assets. When markets faltered in the financial crisis, central banks stepped in

to buy assets through quantitative easing (QE) in effect, an indirect subsidy

of fund managers profits.

As Messrs Reamer and Downing point out, some fund managers have become very

wealthy by looking after other people s money. A quarter of all American

billionaires work in finance and investments, an industry that employs less

than 1% of all workers. In ancient times, the poor looked after the assets of

the rich; in modern times, it is the other way round.

Successful managers deserve decent rewards, but a lot of mediocre managers have

prospered too. Just because they are rich does not mean they are clever. Their

position is slowly being eroded by the emergence of index-trackers and

exchange-traded funds, which charge much lower fees. But the transformation is

not occurring fast enough.

A world of low inflation and low nominal returns should prompt clients to pay a

lot more attention to fees. Instead, many pension funds and endowments are

moving into higher-charging alternative asset categories like hedge funds and

private equity, a Hail Mary strategy that cannot work in aggregate. There may

be market inefficiencies that are profitable to exploit, but none large enough

to give a big, across-the-board boost to the returns of a $22 trillion

industry.

The authors are right that the democratisation of investment is, on the whole,

good news. Millions of people have access to diversified savings vehicles that

will deliver, on average, returns that are better than those available from a

savings account. But, these days, technology means that such funds can be

provided for a fraction of a percentage point a year. This is becoming a

utility business, and you don t get rich by running a utility. Fred Schwed s

question to a pre-war Wall Street mogul Where are the customers yachts?

remains as relevant as ever.