good post 
now rebalancing is a value added service
^I thought it was an excellent curriculum and covered the minimum that a finance professional should be familiar. Chasing alpha or not, there are many occupations within finance that should require the charter as an absolute minimum. A fair filter no doubt.
And just a side note, as you recall, the core-satellite strategy is not consistent with MPT, but is promoted by Taleb. Both strategies are covered in the CFA curriculum. I don’t believe the curriculum or the institute really promotes active or passive strategies. The goal was to expose the candidate to relevant financial concepts. Anybody participating in the regional expert panels? If you don’t like the curriculum, there’s your chance to have an influence.
^I agree with you Ghibli. Many believe/expect that completing the CFA exams will allow you to beat the market, and then are disappointed to find out that isn’t true. The natural reaction then is to declare that time as wasted and the material learned as irrelevant. Just because the expectations were unrealistic doesn’t mean the knowledge is useless.
not all of these active managers are doing nothing for society though. while a large number are index huggers, there are a good number who actually try to allocate efficiently and this does have the effect of lowering the cost of capital for good ideas and raising it for bad ideas. if everyone indexed hugged, innovation would be slower and fraud would be more rampant. in every example, even those outside of finance, do you have people who are in it for the free ride and are only looking out for their, or their team’s or company’s, well-being.
on the flip side, i forget who said it, rousseau maybe, but when all of the lawyers are out of work, revolution is in the air. i deem bankers and other smart high earning folks as equivalent to lawyers in the 1700s. you need to find something for all of these very smart people to do. not all of it can be incredibly productive work. at the end of the day, these guys are working and generally happy and not in the mood to overturn the current system. the societal value of the current banking and asset management business is just as important as its economic value.
So we should advise our clients to pay high management fees as a way to create overpaid jobs that are not really necessary for our economy to function? I’m not sure how I’ll market that strategy but I’m sure it’ll be a hit with clients.
And yes, the work of properly valuing securities is very important. Our markets can’t function if nobody is willing to do the work of finding fair value. However, the market is dominated by active managers when it should be dominated by passive managers. We do not need 5,000 people ‘valuing’ Apple’s stock. That work can be done with less than 10% of that. And lets be real, most of them are speculating.
To your final point, I would not say that these are the best and brightest in our society. Roughly 15% of actively managed funds outperform their benchmarks over a 10-15 year time frame. This group of people who willingly choose to make it their life work to play that game…to choose to play a negative sum game…are not our best and brightest. Our economy is worse off as a result of their work. Take the best 5-10% of those who work in ‘security valuation’ and allow them to price markets, the other 90% should focus their efforts elsewhere so that they can be of benefit to society.
I highly recommend the last few articles on philosophicaleconomics.com for anyone who believes that actively managed funds should make up more than just a small fraction of our investable AUM.
that’s like me saying top 10 in any field or hacksaw. of course there are smart people in asset management and of course the vast majority of them are in the top 10% of intelligence across the western world. the fact that most underperform is a math problem not an intelligence problem. and yes, many end up index hugging to save their jobs. that’s sad and not good for anybody but the manager but the incentive is an obvious one and one that many industry people are trying to fight.
that said, aren’t we quickly progressing to your passive nirvana as we type? i agree that virtually no manager should get paid 1% for hugging an index when you can achieve that for 0.10% or less, depending on the index, but this culling is happening now, in warp speed! that said, there needs to be a large number of active actors to determine who is truly value adding and who is not. it’s not like you can nominate a few guys who are the ultimate perpetually superior active managers and say everyone else is out of a job. as a result, active managers will always have a large chunk of the pie.
is hugging an index a new industry term?
Index huggers under perform certainly. But so too do many who are simply trying to outperform by picking stocks. I bet there are many more of the latter than the former.
It’s something like 80% active in the mutual fund space right now. There’s no reason why 8 out of 10 investable dollars have to start with the premise that what they are buying is ‘undervalued’. A very small amount of the top investors could easily keep markets efficiently priced, and earn a respectable living doing so, with just a fraction of that AUM. We don’t need $9T being actively passed around, racking up commissions and fees. That number is probably more like $1T, if not far less.
As you say, this is occurring rapidly. I think it has a lot further to go than you do. Every time someone embraces the passive approach, there is less AUM for active managers. Less AUM means less revenue. Less revenue means jobs are getting cut. Who’s job? The least qualified. If there are 10,000 active management shops, then there is a #10,000 out there (looking at you Waddell and Reed). When #10,000 goes out of business, then it’s #9,999’s turn to be the loser at the poker table. This should continue until the market reaches equilibrium. Any rational person should be willing to say “I’ll invest in the strategy that gives me the best probability of success”. Right now you’ve got a 1 in 7 shot of outperforming in the active space. That shouldn’t exist. It should be a 50/50 proposition. That is why fund flows are so strongly in favor of passive managers. Passive managers are killing active managers. Active hasn’t outperformed passive in a single year since 2007. Active has outperformed in one year of the past fifteen. What about the risk? Morningstar has a great analysis showing the higher levels of volatility and longer periods of drawdown in actively managed strategies. What about taxes? Too easy, of course passive is more tax efficient.
There’s no logical reason to pursue active unless you can identify winning managers ahead of time. And if that was easy to do then fund of funds wouldn’t be the losers game it is.
my main argument is that the top performers need a place to grow their skills and experience before becoming top performers and that top performers are not always top performers. what you’re saying is like, “minor and junior hockey is a complete waste of money for everyone. how about we get rid of those leagues and just support the nhl quality players.” to which i say, how do you know which person is an nhl player and which person is just STL in hockey garb? also, let’s say you somehow know who all the nhl players are without any qualifying process (which is impossible), how do you compensate these top performers? you have no baseline to compare. if you can invest with a guy who will consistently outperform forever, you will get the risk-free rate and he will get all of the rest.
I agree, we can’t just have two active managers in the entire world setting prices for every asset. But we don’t need two billion either. It’s possible to have too few, and it’s possible to have too many. Right now we have too many, as demonstrated by the dreadful cumulative performance by this group of investors.
Now, you’re also correct in that we can’t simply ordain the next group of people that will be able to effectively value securities. As with athletics, a profession must engage in competition in order to determine who is worthy and who is not. Using your example…yes we must have a ‘minor leagues’ in order to develop talent and help determine who is worthy for the big leagues. However, and this is a perfect example, minor leaguers get paid very little. The average salary in the AHL is $40K. The average minor league baseball player gets paid less than minimum wage. They do this because they believe in their talents and believe the shot at getting paid big money will someday make it worthwhile. If they don’t have the talent, they won’t get paid.
In the same way, aspiring active managers should expect to make less money until they prove they are worth more. The fact that they don’t accept this line of reasoning is the exact reason why money is flowing so quickly to passive management. The rational that I should pay a random guy 1%+ because he claims to have skill is ridiculous. And since 85%+ of active managers don’t have a track record that justifies the fees that they’ve charged, we know that there are too many in the industry, that they’re overpaid and that indexing is the only rational choice unless you can only pick winners. And the idea that a client can find a guy who can find a guy who can pick stocks that will return more than enough to offset all those fees is equally ridiculous and improbable. The industry is changing and it’s got a long long way to do.
Obviously people do NOT pursue CFA to beat the markets, as I have already said. It’s about their career and status/ego, not investment returns.
Yes, the market cannot beat itself. The vast majority of industry people assume (correctly) they can not outperform and are not even in the game. Over and over on AF we hear “you can’t time markets”, “you can’t pick stocks”, “you can’t pick countries”, it shouldn’t be theoretically possible, because you can’t beat the market.
So, the obvious question; what do these “professionals” actually do?? Why not just fire these people and buy ETFs yourself? Oh right, that’s what clients are doing. 
This is great but the chart is not titled (some newbie CFA made it)…
Only 19% say “more knowledge/skills with investments”. But note becoming knowledge is a different motivation than beating markets…this can very quickly turn into a bunch of fancy strategies and rationales for the eventual underperformance. The knowledge/skills need to serve the primary motivation of beating markets. Perhaps the 7% “other” are “to beat the market”, but probably not, more like 3%.
Anyhow, at least 74% are not primarily interested in returns.
huskie, high performers always make more. do you think bill gross and dan ivascyn make the same amount as some random PM who runs a $200M US mid-cap fund? of course they make more.
as for the optimal number of PMs, this number will never be known. it is very likely to be less than the current total but considering there is societal benefit as well as economic benefit related to have a large sum of PMs, i can’t say less is definitely optimal with any confidence. it will be interesting when the day comes when the culling bottoms out and the number of active PMs starts to rise again.
Incorrect. As stated before, the vast majority of invested dollars are with active managers attempting to outperform.
Bill Gross makes more because he has a higher AUM, not because he charges more. If I’m throwing $10,000 in an active fund that charges 1% it costs me the same regardless of who the actual manager is. An unproven manager should charge less as a percentage than Bill Gross. He should charge the same as the low cost ETF or index fund option until he is able to prove that he is worth more. If he proves he can outperform by 50 basis points per year, then the manager can justify charging up to 50 basis points more than the low cost ETF or index fund.
The fact remains that an unproven investment manager has no value to an investor and shouldn’t be paid a single additional dollar until he proves he can add value. A random $200M mid-cap fund charging 1% is pulling in $2M per year in revenue. What have they done to deserve that fee? If I can access the same market through vanguard for 20bps, then that means this manager is overcharging by $1.6M. Why would investors allow this manager to exist unless he can produce, at a minimum, $1.6M in additional value. This is obviously too big a hurdle, as demonstrated by the continual underperformance of active managers, and therefore managers should be getting paid much much less. Fortunately, the world is waking up to this and it’s happening every single day. $290B has flowed out of active in the past year…$2.9B in revenue lost…why? because there is no value for society to pay someone to sit in a room, collect money, and produce returns that are subpar to the low cost alternative. It’s a classic example of removing the middleman and until the middlemen start producing value collectively, this trend won’t cease. $2.9B in lost revenue is going to mean a lot of lost jobs. Considering that the passive/active balance could flip…we’re talking 7T in fund flows, or another $70B in lost industry revenue…it’s going to be real hard for the underperformers to justify keeping their jobs. Good…they can go do something productive with their lives.
I’m not sure why you wouldn’t accept the logic that the appropriate amount of PMs pursuing active is somewhere in the ballpark of 50/50 outperformance of the low cost competition. If one strategy has greater collective performance than the other, that strategy should see more asset flows…this is a market after all.
Well, they market themselves as attempting to outperform (but they expect to fail at that), that’s very different from actually intending to outperform (and having a probable/feasible path to that).
You’re giving them too much credit. Sure, a few people at these companies might understand this, but the PMs, the analysts, the wholesalers…all have had the kool-aid and believe they have a strategy to outperform. It just means they’re not very good at analyzing the obvious performance results in front of their face.
I guess at this point we are analyzing intention , which is extremely important.
Sure, I can understand your theory; big money truly believes in their wacky strategy and intends to beat the market (even though objective analysis shows their nonsense has a low probability of working). However I tend to see these people as spinning bullcrap to investors to get their capital, BUT when we hear them speak candidly they say “you can’t beat the market”, same as 99% of the CFAs here say. So they don’t even intend to outperform, because you would have to believe something is possible, before you could intend to do it.
Anyhow, yeah…I’m a skeptical of this industry.
you’re wrong. bill gross makes more because he performs better. how do you think pimco got to be as big as it got? strong performance. the thing with a big figure like that due to his outperformance and his aura he brings in capital as well as outperforms over time so that has a double effect and his comp reflects both of those things. PMs job duties aren’t to JUST outperform their benchmarks, they are also compensated for fund growth and selling the fund. why would PMs go to $hitty little boardrooms all over north america to sell their fund if their only duty was to outperform?
pricing funds based on performance would be a nightmare and is impossible. so a fund does good one year and they jack up the MER to 4%? i don’t even think you can do that without launching a new fund with the same manager. so fund has a good year, company wants to charge for premium service, so they spend $2M to launch a new fund which all trickles down to the customer.
mutual fund fees are coming down fast in response to ETFs. some ETF companies are launching mutual funds. the cost for run-of-the-mill active management will soon be a more reasonable ~30bps for fixed income and ~70bps for equity. yes, the minor and junior leagues of investing needs to shrink a bit but your take seems to be that somehow we end up with 100 top performers without needing 10,000 minor leaguers to find those 100.
i don’t know why you’re so angry when it is always up to the investor to avoid picking a $hitty fund that perpetually underperforms. if investors all bailed on crappy funds, we’d be at equilibrium pretty quick. that said, you kill a crappy fund and a new crappy fund with a 1/100 chance of being a good fund is launched. it will take a long time for fund numbers to decline substantially. you also have to remember that all managers’ performance falls with size so even top performers will one day become index huggers when their fund size gets too large. many studies in the FAJ concluding this. further, price efficiency will decline as the passive % rises so there will be more demand for active managers when active capital declines.