The big record of the investment industry


Vain efforts
The investment industry in the United States resembles the video rental market at the start of Blockbuster. It’s scattered, diffused, ineffective – but with a hint of something better on the horizon.

Rather than pooling their resources, thousands of institutional pension funds and endowments operate separately, each paying for its investment decisions. Half a million companies offer 401 (k) plans, each different from one another (or at least, obtained through separate negotiation). Tens of thousands of financial advisers select investments for their clients, from a myriad of fund managers.

In a sense, such a variety is admirable. Industry professionals can innovate freely. While fiduciary regulations preclude some approaches, there are nonetheless many ways for pension funds, 401 (k) sponsors, financial advisers, and fund managers to express their individualities by choosing avenues that differ significantly from those of their competitors. They are not judged against a gold standard.

Most of the time, however, this diversity is cumbersome. Too many people work on the same problems and, despite the opportunities for creativity, arrive at the same answers. Such replication is unproductive. Agriculture was no more efficient when it consisted of family farms. Yields increased when these farms combined to become agribusiness companies. Likewise, Blockbuster has made it easier to rent videos. Its stores were duller than what they replaced, but cleaner and generally less expensive.

In short, US investment activity needs a roll-up. This process has already started. Here’s a quick recap, starting with the segment that has advanced the most and ending with the segment that has advanced the least.

Financial advisers
For several decades, leading financial advisers have redefined their practices. Once, they selected actions; then they found mutual funds; then they built portfolios. Today, more and more, they even leave much of the portfolio construction to others, borrowing from outside models. Along the way, they took on a broader view of their roles, serving as general guides for their clients.

These changes make sense. You don’t have to be a financial advisor to appraise investments or even in most cases to create portfolios. These tasks can be accomplished just as well (if not better) by someone who is not overloaded with customer demands. But financial advice tends to be specific, applying to one individual’s situation but not that of another. The advisor can therefore deliver what the general investment researcher cannot.

Financial advisers have experienced a consolidation of ideas, not manpower. Many are predicting the latter, saying that technology will allow financial advisers to expand their reach, so that the strong will acquire more clients, while the weak will be forced to seek other employment. May be. Or, perhaps, the client pie will increase, as existing financial advisors reach out to those they are not currently serving.

Fund managers
In some ways, the often anticipated consolidation of professional investment managers is well underway. The top five mutual fund / exchange-traded fund providers now control 54% of the industry’s assets, down from 45% a decade ago. Passionate financial advisers and direct investors once scoured the charts for “unknown” store managers before the crowds arrived. Now few can be disturbed.

The same is increasingly true of institutional investing. Earlier this month, the country’s largest pension fund, CalPERS, reduce his list active managers of equity funds. The $ 380 billion giant now employs just four of those companies, which collectively manage less than 1.5% of the CalPERS portfolio. Don’t let your babies become equity fund managers.

This, however, speaks in the past tense, not the present tense. Because investment management is so profitable, and because most mandates gradually wither, instead of being forcibly removed, the area has yet to be pruned significantly. The unwashed masses of industry will continue to lose market share, but most will remain in business for many years to come.

Pension funds
This month, Illinois adopted law merge 650 police and firefighter pension funds into two much larger funds. Authorities in Illinois have argued that local funds have posted annual earnings of less than 200 basis points on average than the state’s Municipal Retirement Fund. Part of this variance is due to the higher average expenses of the smaller funds and some to a lower investment return.

Investment performance comes and goes. Just because the aggregate of 650 funds followed the Municipal Pension Fund in the past does not mean that it would have done so in the future. It is quite possible that the superiority of this municipal pension fund is due solely to the luck of having benefited from an investment-style tailwind. However, the benefits of lower costs continue. There is no doubt that the two new funds will benefit from their lower expense ratios.

Such economies of scale make further mergers inevitable. This process is more advanced in several other countries. McKinsey Reports, for example, that the number of Dutch institutional funds was reduced by more than half during the decade from 2005 to 2015. McKinsey foresees “limits” to the merger trend, but these limits are far beyond what American pension funds are like today.

401 (k) plans
Defined contribution plans are the most obvious candidates for consolidation, but also the most distant.

The “obvious” part requires little explanation. Current regulations require each employer to establish their own 401 (k) plan, although few companies assess the investments for a living. Few employers want such responsibility (and the cost that goes with it); they prefer to be grafted onto the plan of another company. Better yet, it would be not to have 401 (k) at all.

The result: Nearly 40 million American workers do not have access to a defined contribution plan. Many more are in expensive plans, not because 401 (k) vendors reap large profits by overcharging small businesses, but rather because of the inefficiencies of the current system. (TV host John Oliver publicly lamented industry 401 (k) pricing for startups, which he was largely right about, but he erred in blaming greed rather than structural stupidity.)

The problem can easily be solved. Morningstar advocated incremental improvements that build on existing proposals. Others scrap 401 (k) provides for it completely, replacing the current system with a whole new scheme. Such ideas are not federal exaggerations. Quite the contrary; today’s plans are governed by a messy IRS tax provision. Changing them would reduce government intrusion, not increase it. They would also demand two-party politics from Washington, so they don’t seem to be happening anytime soon.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for and a member of Morningstar’s investment research department. John is quick to point out that while Morningstar generally agrees with the opinions of the Rekenthaler Report, his opinions are his.


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