It is no secret that many fundamental hedge funds and traditional asset managers have struggled of late. A toxic cocktail of underperformance, high fees, increased regulatory scrutiny and disruptive technology have led to challenges, push-back and, in some cases, redemptions. While industry proponents say it’s cyclical and nothing more than a blip on the radar, skeptics say it may spell imminent transformative change for old-school active managers.
Panelists at the recent Trading Show in New York debated the potential impacts of those trends.
How much are robo-advisers, low-cost index funds, smart beta funds and other actively managed ETFs threatening the traditional fee model? How can hedge funds and other institutional asset managers respond to the increasing threat of disruptive investment technology?
“There’s nothing wrong with fee compression,” said Milind Sharma, the CEO of QuantZ Capital who formerly worked at Merrill Lynch, Deutsche Bank and RBC Capital Markets. “[Earning high fees] is a distinction of alpha providers, mainly hedge funds that can charge two and 20, but there will be less of them, because the world may not need 9,000 hedge funds.
“On the other end of the spectrum, BlackRock, State Street and Vanguard will clean up on ETFs and index funds – it will be very difficult for others to compete, because that’s a very commoditized part of the industry,” he said. “Disintermediation will take place in the middle: the traditional stock-pickers at ‘40 Act mutual funds.”
In a world where there is so much data floating around, asset managers without artificial intelligence and sophisticated big data analytics are overwhelmed by information and may struggle to continue with the old way of stock-picking and justify the fees they charge.
“Some managers are still good at it, but the data does not support a whole lot of alpha in that space,” Sharma said. “The middle [of the active-passive spectrum] is compressed significantly by smart beta ETFs and related products – that’s where the big squeeze is going to come.
“Everything that made Warren Buffett and Bill Miller famous, picking cheap stocks, a fifth-grader can do [using today’s technology] – it’s not rocket science, so why are there even stock pickers?” he said. “Why do they exist?”
Will AI-driven investing make discretionary investing obsolete or complement the traditional model?
“People with no skill that just provide you with beta will get commoditized away,” said Andrej Rusakov, a partner at Data Capital Management. “Big data is a disruptive force affecting investing – the amount of information has grown exponentially, and if you can’t process huge amounts of data in real time, then you will underperform, whereas those who can will win.
“Some discretionary managers look at tectonic shifts in the industry and bet on them,” he said. “For example, the merger arb game is less affected [negatively] by AI machine-learning, and actually those guys are likely to benefit from the advances in AI.
“However, a lot of people will get flushed away, frankly speaking, and it will be all about the quant game moving forward.”
Is it time to re-think the fee structure for active managers?
Hedge fund fees have been high for a while and that’s simply how the world has worked.
“The key question is ‘Why the fees have remained high for decades?’, especially, considering that there are thousands of funds competing for assets in the alternative space. In my opinion, one of the key roles of high fees is to align well the interests of managers and investors,” said Boris Albul, the chief investment officer of QSF Capital Management. “As an allocator, if you have a lot of money to entrust to a manager, you want to create a contract that incentivizes that person to do his absolute best for you.”
But how do you distinguish between which asset managers are justified in charging a higher fee and which don’t deserve to charge such high fees?
“This is a very complicated questions. One thing, though, allocators should be able to avoid is paying high fees for repackaged beta exposures which can be obtained via inexpensive smart-beta products.” he said. “Renegotiating the fees down or looking for low-fee managers is also tricky. Usually, there is a lot of asymmetric information between an allocator and a manger and, therefore, pricing of fees becomes an important source of information about the quality of the manager. Heavily discounted fees could be representing poor investment management skills.
“Fees are there for a reason. As an investor, you have to compensate a skillful manager to do his absolute best in representing your interests.”
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