Asset Management – Swimming in an Ocean of Treacle

Blain’s Morning Porridge, Nov 24^th, 2022: Asset Management – Swimming in an Ocean of Treacle

“Sure.. these beans are the best investment you will ever make…”

This morning: 2022 has been a challenging market, and its likely to reveal to millions of savers just how poorly their money is managed. Its time to have some serious discussions about asset management and how to focus on serving clients, rather than them as big businesses!

Happy Thanksgiving to our American Chums – this morning I’m going off on a rant… and just to show I’m fair, it’s about my own business.. financial markets and asset management!

I am going to risk upsetting some of my largest buy-side clients, but much of the Asset Management business needs a good kick up the behind. (Buy-Side – the guys who invest in all the very clever financial instruments folk on the Sell-Side come up with.)

Let me start by saying the vast majority of investment managers I speak with (my day job) are clever, smart, intelligent, skilled and highly competent. They are a delight to work with. But there are very few that don’t complain (off-the-record) about being trapped in process, tick-boxing and bureaucracy. I can have fantastic discussions on alternative investment opportunities that meet all their requirements, but then get blocked in the process – that’s the way the business works, but it increasingly feels like we’re all swimming in an ocean of treacle.

2022 has a massively challenging year for everyone – a reversal of the last decade of never-ending market gains that’s required taking a wholly new perspective on likely market outcomes. However, I don’t get the sense all funds are aligned with seizing the opportunities or avoiding the pitfalls this topsy-turvy market has presented.

All that really matters in the investment business should be maximising returns while preserving value. Buy bonds for security and equity for risk and growth – hence the old 40/60 portfolio mix. To meet the financial goals of their clients, asset managers need to include factors like diversification, security and liability matching.

But of course, its more than that. Its about being clever and understanding how markets work. When folk entrust managers with money to invest on their behalf they are entitled to expect service. Folk like myself, saving what few pennies are left after government incompetence to fund their retirement, want to know our money is safe and competently managed to achieve the best outcomes.

But it’s not really happening.

Right across Fund Management, there is a trend towards scale – where larger and larger funds not only dominate markets, but stultify the whole business as they become progressively more and more bureaucratic and corporately run. Successful investment requires more than lots of money to invest and analytical competence, but also flashes of insight and inspiration. Insights are easily lost in the fog of bureaucracy, committees, management intransigence and groupthink that always dominates big firms.

The key metric remains: it basically costs as much to manage $100 million as it costs to manage $100 bln. Scale = profits, but not competence. But the bigger a firm becomes, the more difficult it is to retain originality.

Instead of results, the big firms seek to differentiate themselves through marketing and advertising, hence far more weight is given to bragging about ESG credentials and how many trees they’ve planted, than explaining the multiple reasons for sub-standard underperforming returns.

Looking at my own savings its abundantly clear some well-respect fund managers are little more that fee gathers dressed up as asset managers. As exhibit 1, let me cite one South-East Asia fund I invested in years ago: it is worth less than I originally put in, despite local markets being multiple times larger. The manager has happily skinned me for repeat fees year after year. I’ve tried complaining. It’s a nightmare. I am expected to provide the data – even though they ran the portfolio!

Fee farming sums up one aspect of the business. The other is cutting costs and effort by simply indexing versus the stock markets. Too much of the fund management game is an optimisation game of maximising fees and minimising costs. Generating returns for savers comes well down the list. And there is the fund management genetic problem: young fund managers learn their trade dominated by group think and “how-its-done”, and within a few years they are running the business on that basis.

It’s not that the Asset Management business in inherently evil and deliberately taken us to this point. But it has become a faceless, fee driven, index-following, bureaucratic process as a consequence of the last 14 years of Market Distortion.

QE, ultralow interest rates, and mispriced markets have had a massive effect on fund management. When every single asset class is remorselessly bullish – pretty much the case since 2010, then it’s easy to boast about making great returns by simply following the market and trends.

The QE distortion era changed the basis of relative risk – by distorting the underlying risk-free rate represented by government bonds by making govt yields artificially low. That changed the risk/return on every single other asset. As a result risks on bull stock and corporate bond markets have been significantly under-estimated as markets rallied, but have been widely accepted as new market truths. They aren’t – the market remains distorted, but multiple cohorts of investment professionals have learnt their business during the last 10-years believing it to be normal.

They must be looking at 2022 in some shock. 2023 is likely to reveal even more painful truths.

I’ve written many times about how few financial professionals have ever seen truly difficult market conditions. Only 35% of financial professionals were around for the financial crisis of 2008, and most of them would have been relatively junior at the time. Even fewer have history going back to the dot.com bubble bursting in 2002, or the Black Monday crash of 1987.  (I was there!).

But old blokes like me are little use as managers today – we learnt our trade before diversity and mindful wokery dominated management style and approach. We call spades spades, and expect folk to take responsibility for their actions – which is clearly unacceptable in today’s kinder environment. That said, experience is tedious. I can imagine there is nothing worse for a bright clever young money manager listening to Bill Blain droning on about the Perp Crash of ’86, or havering about the lessons from the Sovereign Crisis of 20-12.

And experience can be deadening. It’s easy to get stuck in rut: like a bond manager who has been playing the same credit arbitrages year after year after year? Or a stock picker who has simply plopped his chips on “oil and gas” these last 30 years. There is new stuff – from derivatives, structuring, crypto, technology, whatever, to learn everyday. My current “thang” is getting a grip on climate change tech, renewables, climate mitigation and carbon markets.

I might even add a new Blain’s Market Mantra here:  “Never trust a fund manager who has spent his whole career doing the same thing at the same firm, unless they are consistently in the top 10 percentile – when their specialism might just be worth something.”

Diversity of ideas and thinking is important. The last 12 years of distorted bull markets has been good and bad. Savers have been able to easily follow markets higher, but once the market flipped  millions of savers have lost money jumping on trends that marketing departments have driven and sponsored – the most famous being dressing up Cathie Woods incoherent expectations on disruptive technology and flogging it as investment genius. Wrong. Speculative hype.

And then there is regulation. Asset Management has become a bureaucratic gloop largely due to tidal wave of over-regulation that followed the GFC in 2008. Its now a job that involves constant form filling, tick-boxing and irrelevant reporting that has crushed the economics of fund management by raising the need for a plethora of risk managers, compliance officers, regulatory oversight directors etc. There are an awful lot more polishers of big brass doors today than when I was young!

The reality is regulating for everything means regulating nothing.  Things still go wrong, as we saw earlier this year when the mad, bad and dangerously wrong UK mini-budget farrago nearly broke the gilts markets – when the scale of market moves triggered massive margin calls on highly levered gilt-based structured products, causing holders to exacerbate the crisis by being forced to sell gilts into a crashing market! The lesson was clear. Risk is not the only risk. Consequences across leverage and liquidity, plus just about every other vector you can think of matter.

The result is an industry that found itself massively unprepared for what this year has brought. It is going to remain challenging. The future will remain about spotting the predictable no-see-ems like Central bank and Political “policy mistakes”, and coping with the unpredictable no-see-ems like the Ukraine War, Energy Price Spikes, The Pandemic and consequential market collapses.

Risk Management is now a science, so I’m told. There is plenty of data to track, analyse and use as a tripwire to quantify the multiple risks, hedges and mitigation strategies, but the human element remains critical. Risk and Fund managers need intuition and experience to override imperfect algorithms, misread charts, and basic human fallibility. Any data is out of date that moment it is produced. And there is simply too much data to understand every nuance.

This may all change in the near future. Speaking to some really nerdy techs, they reckon we are only 5-10 years away from quantum computing solutions in the market. New Quantums may be able to more accurately predict the peculiar behaviours of markets, trends and likely market moves with greater precision and success, and be able to present data in easy to understand ways allowing fund managers to better interpret and communicate the implications of what they are doing.

And then there is new competition. Earlier this week I briefly mentioned the threat of Apple, Amazon, Meta and Google deciding to get into wealth management… the data they hold on us is extraordinary.

Of course, you could avoid these problems by using smaller, maverick boutique style firms where you can check managerial competence and question their approaches. Shard Capital, my employer offers various institutional and high-net worth targetted funds and is clearly highly competent by hiring myself (ahem), but small firms, specialist funds, and investment strategies such as small caps, corporate bonds, or disruptive tech, are not immune from self-immolation.

Out of time, and back to the day job..

Bill Blain

Strategist – Shard Capital