I am reading a slightly niche book: The Origins of Asset Management from 1700 to 1960 by Nigel Edward Morecroft. It isn’t exactly what most people would consider leisure reading, but if you like a bit of financial history or you work in fund management it is worth perusing as a reminder of why the industry exists and what it is supposed to do for markets and investors.
The period takes us through the development of the modern company, from entrepreneurs working in partnerships and small-scale businesses funded by individuals to the rise of the business corporation and the modern, listed, limited liability corporation.
Flick through the first chapters and you’ll see a familiar-looking industry beginning to develop from the late 1800s. Investment trusts emerged with a view to offering the newly wealthy (as a result of a combination of the British empire and industrialisation) somewhere to put their money other than in pathetically low-yielding government bonds. Yields fell relentlessly in the 100-odd years from 1815.
Look to the shareholder lists from the Foreign & Colonial Investment trust in 1881 and you can see the industry developing to serve this new audience. Aristocrats and women didn’t have their occupations noted — just their titles and marital status respectively. But the men listed are leather cutters, warehousemen, flax spinners and farmers. They were ordinary people handing their money over to be pooled and invested by trusted experts in the hope of a better future.
The difference between then and now
Read the rest and you will begin to see the difference between the industry that developed over Morecroft’s 260-year sweep and the industry we have today. The most impressive of the investors mentioned in the book were, he says, “creative, hardworking, intellectually tough, determined and often from unusual backgrounds — typically from outside establishment circles”.
They lived at a time in which “a modest background and limited education were no barriers to success”. Robert Fleming, the driving force behind the Scottish American Investment Trust, had a working-class background and left school at 13, for example.
They were outward-looking and flexible in their thinking. Fleming, a great believer in “the power of information” and the importance of shareholders being involved in the businesses in which they were invested, made 64 visits to the US over 50 years in the name of research. This was no small feat given that, when he started, each crossing of the Atlantic took 16 days (it was down to five by 1900).
The genuinely transformational money managers had the long-term support of their backers. Fleming’s recommendations from the US were taken by his trustees despite the fact that he started giving them at the age of 23. John Maynard Keynes, one of the founding fathers of modern investment as well as a pioneering economist, had the full backing of King’s College, Cambridge, even when he went through a very dodgy performance patch in 1931. And George Ross-Goobey, possibly the most transformational of the lot, was given complete freedom by Imperial Tobacco to transform its pension fund.
They had proper long-term and global horizons: the first trusts were established on the basis that they would remain invested for 20 years or more. They were also both socially useful and seen to be socially useful. Looking at the relatively benign shift of political power from aristocrats to the middle class, Morecraft asks whether a supporting factor was the rise of the investment industry, which helped move economic power from one group to the other and create long-term capital for infrastructure development. Maybe.
Finally, and crucially, they were free, by which I mean unbenchmarked. The UK’s pioneering investors knew nothing of indices, “restrictive investment policies or short-term measurements of relative performance”. They figured their job was either to produce more income than government bonds or to maintain real spending power by matching or beating inflation. Simple, straightforward, long-term stuff.
I wonder what they would have made of today’s industry with its groupthink, general lack of interest in social purpose, high fees (if 0.25% worked in the 1800s, why can’t it work now?) and bonkers incentives around benchmarking. I suspect not much.
The modern dangers of underperformance
With that in mind I’ve also been reading a paper just out from the European Corporate Governance Institute. It’s not for the faint hearted — Morecroft’s book is chick-lit in comparison. But its authors have had a go at figuring out how dangerous it is for fund managers – and hedge fund managers in particular – to underperform a set benchmark for a couple of years. The answer is “very”.
According to their calculations, the “scarring effect” on a top manager whose fund ends up liquidated after persistent poor relative performance (note the word “relative”) comes to a “yearly average compensation loss of $664,000”, thanks to “loss of reputation”.
Quite right too, you might think. But there is more to it than that. Outperformance cannot come without the risk of underperformance, and a system that severely penalises the latter is unlikely to get as much of the former as it might think it should, hence the prevalence of the “closet tracker fund” in the UK (these are funds that pretend to be active but in fact more or less track the index).
In Fleming’s day, relative performance didn’t exist. Today it is all that matters to a fund manager’s career. The way to keep his outsize income rolling in, once he has established a good reputation as an effective manager, is not to be a particularly effective manager — but an average one. Fund management has come a long way since 1700. Just not necessarily in the right direction.