Living off the people
A history of investment shows how managers have prospered
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.