As a profit-making endeavor, managing other people’s money is hard to beat. The business requires very little invested capital. There are no worries about getting paid in full when the bill comes due, since fund managers control their customers’ money. And lackluster performance is no bar to hefty profits because fees, based on the dollar value of assets under management, are paid even when returns are abysmal.
Wall Street, it often seems, is exempt from the laws of economics. Most active money managers produce worse returns than an index, such as the Standard & Poor’s 500. But making enough money to look respectable to clients has been relatively easy as long as falling interest rates boosted the value of most asset classes.
What’s more, new competitors constantly enter the business, yet rarely discount fees to gain market share. Instead, funds rely on investors to chase the latest high- performing manager, like gamblers who ignore their losses while seeking a hot slot machine. This has given the business a pricing umbrella that shelters it from competition.
Charlie Munger on Discount Rates and Opportunity Cost
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From the owners’ standpoint, all this has been fabulous. They work in a business that produces abnormally high profits and forgives incompetence, a rarity in modern capitalism.
Human nature being what it is, I have never met any money managers who believed their own bad results had anything to do with personal incompetence. Rather, investment firms are keenly aware that the talent they possess costs money; hence managers feel no sense of irony when summing up a laggard year with, “It was a good year for us. I only wish it had been a better year for our clients.”
But after a couple of decades in which asset managers floated along in ease and splendor, economics is now grinding down the business. The easy money is going away. Investment management is in the early stages of a historic transformation. Like most tectonic shifts, it probably will take years to fully develop.
The signs are clear. Stanley Druckenmiller, who had a long record of prescience as the founder and chairman of the $12 billion Duquesne Capital Management LLC, was the first notable figure to act on the new reality. He returned his clients’ money in 2011 because managing such a large fund was “having a clear impact” on his performance, he told Bloomberg News in 2010.