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It’s a miserable life being an active fund manager these days.
The problem is that people are starting to notice that they don’t provide value for money. Customers are flocking to cheap index funds.
Now, even politicians are getting in on the act. They’ve realised that one reason fund managers don’t hold overpaid chief executives to account is because they collect pretty chunky pay packets themselves.
So do active managers have a future? And if so, what does it look like?
Jeff Fairburn – the man who convinced us all that enough was enough
Jeff Fairburn, former head of housebuilder Persimmon, may have marked “peak CEO” pay. He acquired multi-generational wealth by managing to stand in the right place at the right time when his sector was flooded with taxpayers’ money.
Whatever Fairburn got paid for, it wasn’t his talent and it wasn’t the result of competition for good executives (which are the usual nonsense excuses trotted out by people trying to pretend that this is something like a free market).
It’s because he was lucky and the people in charge of setting his pay didn’t do their job properly, because they weren’t incentivised to care all that much themselves. They at least had the good sense to step down when they realised how badly they’d messed up.
Anyway, Fairburn’s life-changing package may have had one benefit. Its extraordinarily egregious nature – and his utterly unapologetic “I’m all right Jack” attitude – has made it impossible to ignore.
Which is a good thing. Because while his pay packet stood out due to its scale, he was hardly unique in being an overpaid CEO. Most FTSE 100 CEOs are overpaid.
And last week, in between voting on exactly what kind of Brexit they want to reject next, Britain’s MPs last week managed to put out a report out condemning this level of overpayment. It contained the usual stuff you’d expect – a lot of angry bluster, some over-simplification and threats of heavy-handed government intervention.
But the core points are absolutely correct: the reason that executives get so much money is not down to a shortage of people for the job or a surfeit of talent, it’s because remuneration committees are soft touches. And it’s because the other people who are meant to hold them to account – the owners of the companies, the shareholders – are all on rather large pay packets too.
This is something that we’ve often argued in MoneyWeek: that one big reason for the executive pay problem is that fund managers don’t want to be the people to lob stones from the precarious comfort of their glass houses.
The FT quotes from the report: “We do not have confidence in… institutional investors in exercising their stewardship functions, in a way that consistently bears down on executive pay.”
This isn’t the only headache for active fund managers right now. The industry is already under pressure from the rise of index investment (I try to avoid using the word “passive” these days, as I feel it’s a misnomer).
Investors are increasingly resistant to the idea of paying a lot of money to a human fund manager who can’t consistently do a better job than a fund that simply tracks the market.
Again, it boils down to the same thing that MPs are complaining about: “What exactly are we paying you people for?”
And that’s a question that active fund managers will have to answer if they want to stay in business.
If active managers want to stay in business, they have to act like owners
So what is the answer? To get more active.
“Activist” funds are, effectively, professional troublemakers. They target struggling or complacent companies, and try to change the management or break up the company or change specific policies in order to create value for shareholders.
Managements hate them, because they are inevitably trying to force through changes that managers don’t want. And historically, “ordinary” fund managers have either sided with management, or have strategically used activists to do their dirty work.
But increasingly, that’s no longer seen as being the best route.
According to data from Lazard, quoted in the FT, activism among “normal” fund managers (as opposed to dedicated activist funds) is rising fast. “Last year smashed records for the volume of activist activity, from the number of campaigns to the amount of money deployed”, notes the FT.
As Kai Liekefett of US law firm Sidley Austin tells the paper: “There’s an enormous shift from actively-managed funds to passive funds or index funds. For active funds to remain relevant, they need to do something.”
It all boils down to this: if you can’t easily beat the market, then what can you do that a computer and an administrative team can’t? What is your sustainable competitive advantage? The only answer can be to wield the power that should go with ownership far more aggressively.
There’s a perception, for example, that “young folk” are more interested in investing ethically than ever before. (I personally think this is drivel – ethical investing has been around for decades, and pretty much everyone whose only involvement with investment has been to tick boxes on a pension scheme expresses at least an interest in “ethical investing”. I think it might be more accurate to say that today’s yoof have a strong sense of their own moral self-righteousness. In other words, they are exactly the same as every other generation before them. But I digress.)
The big index managers such as BlackRock and Vanguard are increasingly making noises about sustainability and responsibility and the rest of it. But given the sheer number of companies they own stakes in – and the diverse base of their own investors – that’s going to be a difficult thing to roll out in a meaningful way.
Active investors are in a much better position to set out “mission statements” and policies for acting as highly-engaged owners who hold managements to account. The thing is, that will mean they have to do a lot of things differently.
They’ll have to communicate exactly what they stand for, and they’ll probably have to take fewer and bigger stakes. And in the end, it might be too difficult. But it’s a choice between offering ordinary shareholders who actually care about this stuff more clout – or slowly being whittled away by regulation and by competition from index providers.
I’m going to start taking a look at the sector in more detail – the share prices of most fund managers have fallen hard and you have to wonder if there are attractive opportunities there. But the challenges facing them are formidable.