The Depressing State of Money Management
According to a report issued by Deutsche Bank, the hedge fund industry now has $3 trillion in assets under management, compared to $539 billion just a dozen years ago. While the industry has grown significantly, it is still dwarfed by mutual funds and ETFs, which hold $13.9 trillion. From an economic perspective, hedge funds can’t be too far behind, given their substantially higher fees, and the growing portion (30%) of passive assets managed by mutual funds.
The hedge fund industry is following down the same path as the mutual fund industry: the biggest firms are enjoying the highest growth rate and dominate the market. The Deutsche Bank report finds that since 2008 firms with more than $5 billion in AUM have grown 141%, compared to 53% for firms with less than $5 billion. They also estimate that less than 200 hedge fund firms account for more than two thirds of industry assets.
In the mutual fund business, the top 10 and 50 firms control 58% and 85% of the industry’s assets respectively. Just as in the hedge business, the big brands dominate the mutual fund business. As time goes by, it is becoming harder and harder for small boutiques to raise money and compete with the name brand hedge fund and mutual fund behemoths. Brand matters more than performance.
Of course, hedge funds are also following mutual funds toward performance mediocrity. While one has to be careful about making proper comparisons between particular hedge strategies and their benchmarks, the evidence strongly suggests that hedge funds do not add value. Nonetheless, the Deutsche Bank report indicates that institutional investors expect to increase their allocations to hedge funds.
Money management has to be the most irrational business in the world. We now have forty or more years of evidence that traditional active money managers can’t beat their benchmark. We know that their fees and trading activity largely guarantee that they won’t excel. Nonetheless, nearly $10 trillion is still tied up with active mutual fund managers, and another $3 trillion is committed to hedge funds where the fees and expenses are two or three times higher than conventional money management. In any other industry, this dismal performance record would have long ago led to the industry’s demise.