Asset Managers, Or Money Gatherers?
Monday, 2/09/2015 20:10
How to tell the difference. And why you need to...
EVER heard of Edward G. Leffler? No, we hadn't either,
writes Tim Price on his ThePriceOfEverything blog.
But in the words of author and
Wall Street Journal columnist Jason Zweig, Leffler was:
"...the most important person in mutual fund history..."
The financial services industry is not exactly awash with innovations delivering tangible social value. The former Federal Reserve chairman Paul Volcker once suggested that the only useful banking innovation was the ATM machine. Leffler's claim to fame? He invented the open-ended fund.
Leffler originally sold pots and pans. But he was not slow to appreciate that selling investments might be more lucrative. In March 1924 he helped launch Massachusetts Investors Trust, the first open-ended fund. Its charter stipulated that "investors could present their shares and receive liquidating values at any time."
Its impact was similar to that of Henry Ford's development of the assembly line. It turned asset management into an industrial process. Whereas closed-ended funds contained a fixed amount of capital, open-ended funds had the potential for unlimited growth. As Zweig fairly observes, like any human innovation, the open-ended fund could be used for good, or ill.
He cites Alfred Jaretski, the securities lawyer who helped to draft the Investment Company Act:
"As there is normally a constant liquidation by shareholders who for one reason or another desire to cash in on their shares, the open-end companies must engage in continuous selling of new shares of stock in order to replace the shares so withdrawn...Under these circumstances, and with keen competition between companies in the sale of their shares, it [is] natural that some questionable practices should [develop]. It furthermore bec[o]me[s] extremely difficult, and in some instances impossible, for any one company or small group of companies to raise standards and at the same time compete with the others."
At a stroke, the invention of the open-ended fund created a schism in the asset management industry. Institutional investors would thereafter have to make a choice. They could be asset managers, or they could be asset gatherers. But they could not be both. Zweig describes the split as one between an investment firm and a marketing firm. The difference?
"The marketing firm has a mad scientists' lab to 'incubate' new funds and kill them if they don't work...charges a flat management fee, no matter how large its funds grow...keeps its expenses unacceptably high...refuses to close its funds to new investors no matter how large and unwieldy they get...hypes the track records of its tiniest funds, even though it knows their returns will shrink as the funds grow...creates new funds because they will sell, rather than because they are good investments...promotes its bond funds on their yield, it flashes 'NUMBER ONE' for some time period in all its stock fund ads, and it uses mountain charts as steep as the Alps in all its promotional material...pays its portfolio managers on the basis not just of their investment performance but also the assets and cash flow of the funds...is eager for its existing customers to pay any price, and bear any burden, so that an infinite number of new customers can be rounded up through the so-called mutual fund supermarkets...does little or nothing to warn its clients that markets do not always go up, that past performance is almost meaningless, and that the markets are riskiest precisely when they seem to be the safest...[and] simply wants to git while the gittin' is good..."The investment firm does not."
Ultimately all fund managers must make a choice. As Zweig puts it, your money manager can be a marketing firm, more or less, or it can be an investment firm. But it cannot be both.
There's a fairly easy way to tell if a firm is a marketing firm or an investment firm. Do you see its advertising on buses, cabs and posters? Do they have a practically limitless range of funds?
This is not to denigrate marketing firms entirely. But as the financial markets lurch between unprecedented bouts of bad policy, and achieve valuations that we strongly suspect are unlikely to persist, it may be worthwhile to consider the motives of the people charged with managing your money. Are they asset managers, or asset gatherers? The answer may have some relevance for the sanctity and stability of your portfolio. And for your peace of mind.
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