At Investorside's Independents' Day conference of independent research providers on April 8, Suzanne Duncan of the IBM Institute for Business Value reported some startling results from a study of the current state and likely future of the financial industry. Undertaken jointly with the Economist Intelligence Unit and the CFA Institute, and surveying 848 financial markets executives worldwide and 107 of their corporate clients, the study found:
- 70% of the institutions' corporate clients said that their providers put their own interest first, not their clients'. 60% of industry executives surveyed admitted to the same thing.
- Only 10% of hedge funds deliver alpha -- that is, do what they're paid to do.
- Within twenty years, 85--90% of assets under management will be invested in passive instruments such as index funds.
That last forecast (if correct) means pretty much that the money management business as we know it is going to evaporate --though Ms. Duncan, asked what the near-end of active investing meant for the analysts filling the room, did suggest that there would be demand for research (and presumably advice) in asset allocation.
I asked Ms. Duncan: if 85-90% of funds are passively managed, who's going to set prices? She said that academics who have made even more radical forecasts have suggested that price discovery can be adequately handled by those managing just 5% or even less of total assets.Personally, I'm all for index investing. I've always suspected that 90% of hedge funds were frauds, and that only the best-endowed institutional investors, such as the the top Ivies, had both the acumen and the financial clout to get into the relative handful of truly effective hedge funds under favorable terms. But as Jonathan Clements, the former Wall Street Journal personal finance columnist and evangelist for index investing (now Director of Financial Guidance for Citi's fee-only MyFi advisory service) once wrote, those of us who invest in index funds and other passive vehicles are parasites in a sense, profiting from the collective wisdom of active managers without paying for it. Though I'm not qualified to judge, it strikes me as dangerous to have multi-trillion dollar markets depend for price discovery on the active investment decisions of those managing a tiny fraction of the total assets.