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FT Article: Asset management lies between brain surgery and estate agency

Thursday 6th July, 2017

Fund houses should differentiate themselves through philosophy and style, says John Kay

By John Kay
732 words
30 June 2017
Financial Times – FTfm (

Copyright 2017 The Financial Times Ltd. All rights reserved.

The asset management sector in the UK is very competitive, but not very price competitive. This seeming paradox runs through the Financial Conduct Authority’s report on asset management, but is never adequately recognised or explained. But only by acknowledging it can regulators help to create an industry that works better for investors and for the economy as a whole.

In a modern economy, most products, including the services of asset managers, are complex and multidimensional. Whenever this complexity is found, producers will focus on those aspects of their products that are salient to their customers. In recent decades, this selective focus has facilitated abuse of consumers. Cheap printers need refilling with costly cartridges, the sticker price of the car is, in time, inflated by necessary extras and overpriced spare parts, and energy groups and mobile phone companies offer appealing tariffs that turn out to be more expensive than you think.

And yet the FCA — and the Competition and Markets Authority, which effectively sets the guidelines within which the FCA assesses competition — are in the grip of a facile model of competition based on a theory of rational economic man. Before making a purchase, rational economic man must access — obtain the information he needs; then he will assess — appraise that information in careful and considered fashion; and finally act on the basis of this process of extended scrutiny. Of course, real people are watching Netflix, making dinner and using their smartphones to keep in touch with their friends. In the meantime, those who work in the always-expanding compliance departments of asset management companies are burning the midnight oil refining key information documents which, as the FCA’s own research shows, are opened by almost nobody at all. We should not be bemoaning this lack of customer engagement, but rejoicing that the population mostly has better things to do.

Asset management is one of a group of products — like brain surgery and estate agency — that is not very price competitive because quality is hard to judge, particularly in advance, and it is worth paying a lot more for an outcome that is better. Some brain surgeons earn a lot — and note that they earn more in a competitive market, such as the US, than in a monopolistic one such as the UK — because it is not easy to become a brain surgeon. Estate agents charge a lot, although estate agency is not especially profitable, because anyone can rent a high-street frontage and put up a sign saying “estate agent”.

Asset management lies somewhere between brain surgery and estate agency. There are few barriers to entry, but economies of scale require that you achieve size or establish a niche. As a result, asset management profitability is high, especially if you add back the substantial share of profit that is paid to senior employees.

The element of the asset management product that is salient to both institutional and retail investors is the promise of future performance, and asset managers therefore focus on past performance. They know their potential customers have not read — why would they have? — the research whose findings the FCA has painstakingly confirmed. A wide range of studies now show — perhaps counter-intuitively, because it is not true of brain surgery or estate agency — that, in asset management, past performance conveys very little information about the future.

Greater transparency of charges will do little harm, but will also make little difference. Those customers who do focus on price are sensibly migrating to passive funds. In that segment, price competition has intensified and scale economies are concentrating funds into the hands of a few very large managers.

The FCA report gropes towards the right solution for the active sector, but you have to work hard to extract it from the report, and some of the report’s recommendations actually get in the way. Asset managers should differentiate themselves, not by spurious promises of risk-adjusted outperformance relative to some broadly based benchmark, but by proclaiming their distinctive philosophy and style.

And the question “what are the unique characteristics of your asset management approach?” should be the principal topic of discussion at the beauty parades conducted by and for institutional investors and financial intermediaries.

Only in this way will competition work as it should in this industry: as a selection process that favours asset managers who generate long-term returns for investors by deep and distinctive understanding of the underlying investments.

Copyright 2017 The Financial Times Ltd. All rights reserved.

Author: Style Research | Categories: News, Portfolio Analysis

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