Oxford professor: Compensation for asset managers is “legalised robbery”
One of the fundamental drawbacks with active fund management is that any proceeds from it generally accrue to the active managers themselves, their shareholders and other intermediaries, rather than to the people who actually pay for it.
Think of it like gambling. Betting firms are businesses; they need to make profits. You may be lucky sometimes but, over time, the chances are that you will lose money. The first rule of the casino is that the house always wins, and active management isn’t any different.
In many ways, though, active management is even more rigged in favour of “the house” than betting is. Ludovic Phalippou, Professor of Financial Economics at the University of Oxford, has written a hard-hitting comment piece in the Financial Times, entitled Enough of robbing pensioners: time to change the system, in which he chastises asset managers for their “heads we win, tails you lose” approach to fees and charges.
The essential problem, he says, is that asset managers share a fraction (and a large fraction at that) of the profit, but they don’t pay a fraction of the loss. In other words, investors has to pay the fees even if their funds underperform the market, as almost all funds do over the long term.
“With one-sided compensation,” he writes, “each year money leaves the pocket of pension funds (and that of other asset owners) to fill the pockets of whoever was on the right side of the market.
“After a number of years, by design, there is no money left in pension funds and all the cash will have flown into some alternative fund manager pockets. The speed at which this occurs is primarily a function of fund manager return volatility (rather than the level of fees): with high volatility, the “money drain” occurs more quickly.”
Worryingly, Professor Phalippou likens the resentment building up as a result of this misalignment of interests to the bitterness and frustration that led to the Leave vote in the Brexit referendum and the election of Donald Trump.
“Fixing compensation is an emergency,” he warns. “A society cannot operate when most of its members are resentful. Resentful voters will back any lunatic promising to “drain the swamp” or paint false figures on the side of a bus.”
This is not the place to stray into politics, and I actually disagree that public resentment at the fund industry has built up to the extent that Professor Phalippou suggests. In my experience, most people are blissfully unaware of quite how much of their returns are being swallowed up by fees and charges.
But it surely isn’t sustainable that a hedge fund manager like James Simons was paid $4,657,534 per day in 2017, when all three of his funds comfortably underperformed the S&P 500? Just think about that. That’s equivalent to £3,531,528, or almost €4 million, every single day — including weekends and holidays. Given that his investors would have been better off last year investing in a simple index fund, you could even argue that he shouldn’t have been paid at all.
Ludovic Phalippou, then, is right: people have a point in seeing this sort of compensation as legalised robbery. Fixing the problem has become a matter urgency.