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Size matters – it’s about alignment of interests

Summary

Previously we’ve mentioned the importance of size in our industry; usually after a weekend FT article bashing active managers. The point we’ve made repeatedly is that those articles normally start from the wrong point.

Previously we’ve mentioned the importance of size in our industry; usually after a weekend FT article bashing active managers. The point we’ve made repeatedly is that those articles normally start from the wrong point.
The fact is that for large-scale asset managers it is often the case that their size of assets under management makes it harder to invest in the assets that are likely to generate the excess performance or ‘alpha’.
It still makes me wonder why I get marketers starting their presentations extolling the fact that they have tens or hundreds of billions under management. While they may be alluding to some form of financial strength allied to a brand name and possibly being ‘too big to fail’, to me that means they are likely to be ‘too big to succeed’ in managing the assets of our clients to achieve the required consistency of returns.
At the end of 2013, we wrote a piece called ‘Appropriate Investment Management’. It reflects on the greater use of equities in pension fund assets halfway through the last century when equities yielded more than gilts. The instigator of that change in asset allocation, George Ross Goobey, focused on the long-term benefits of investing in smaller companies.
Today much active management revolves around large investors such as pension funds and sovereign wealth funds and large investment managers. The industry has become (too) comfortable with relative measurements to indices, convenient labels such as ‘emerging markets’ and the silos that make it easier for large firms or pension funds and their advisers to manage investment teams and scalable pots of money.
For investors, it is possible to look beyond the vertical constraints of debt and equity segmented by credit rating or geography. It was ten years ago that GARS was constructed at Standard Life Investments by Euan Munro and made horizontal investing across asset classes fashionable by offering a decent margin above cash. Euan has moved on to run Aviva Investors but multi-asset strategies are popular scalable investment solutions today.
If you’re not a large investor or asset manager, do you need to constrain yourself with their inhibitor – size!? As well as large asset management businesses trying to deploy billions, large investors have a similar problem. Consider that one of the world’s largest pension funds, the California Public Employees’ Retirement System or CALPERS as it is often referred to, stopped investing in one of its more successful strategies because the optimal size of its investment made next to no impact on the returns of the overall plan!
For most large publicly quoted asset managers, the key is to manage a lot of money and charge a fee for doing so. While decent performance can accentuate the inflows, the focus is on returns to shareholders, which for some means placing asset gathering above consistent performance delivery. To be aligned with those asset managers, is it more relevant to buy their equity than invest in their investment products? One acid test is to ask how their fund managers are compensated – by assets or performance? Often it’s a combination of both but there was at least one instance recently that suggested flows took precedence over performance.
So why do so many smaller investors give their money to large investment firms? Certainly familiarity is a key reason, a comfort blanket or a form of due diligence, many might remember the phrase ‘nobody got fired for buying IBM’.
In short, active management does work, not least when it isn’t constrained by size. If you can’t do the work to find those investment firms that won’t let size compromise their returns, we can do that work and unearth those kindred spirits that aren’t too big to succeed. Our aim is always to deliver investment solutions or find their components that meet relevant investment objectives.
After all isn’t it more appropriate to preserve capital in real terms, i.e. above inflation and by a margin that is commensurate with risk tolerance than refer to market indices as a benchmark? Would you prefer your managers to have conviction across a diversified portfolio rather than owning something because it’s in an index? We would.
Submitted by Peter Askew

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