In the past few months, I’ve had a few asset managers lose their cool with me over my incessant calls for fee and cost transparency. One prominent manager told me (in a voice that could best be described as “whelling” — whisper yelling) that if any clients don’t like his firm’s fees, then “they should just [expletive] fire us. Because I promise you, Ashby, these public pensions out in middle America ... they will never be able to do what we do.” And then this smug man looked at me, held his microphone out to the side and dropped it. Reveling in his own complete and total awesomeness, he left me staring out his window at Central Park. (All of it.) It was then that I had the following realization: If we as a species want to survive, we have to get a handle on the fees and costs that asset owners are paying asset managers.
I get why asset managers are frustrated with me for raising the fee issue so publicly; I’m sure it’s annoying for them to have to answer real questions about their business. But my reason for pushing fee transparency stems from the observation that we need to fundamentally change the business of asset management if we are going to have any chance of solving some of the intractable problems of our generation. And the only mechanism I’ve identified to catalyze real changes among the asset owners is militant fee and cost transparency.
As I’ve argued, resource scarcity, inadequate infrastructure development and climate change all represent major challenges and projects that will require the mobilization of massive pools of capital (a.k.a. we have to find a lot of money fast). But this mobilization simply is not happening. We still have huge gaps in infrastructure and energy innovation financing. I understand that it’s not an investor’s job to solve climate change. But I also know that any investor that does will be handsomely rewarded for doing so. Why then can’t we find mechanisms to unlock this capital?
The answer is simple: time. We don’t have enough investors with sufficient duration to actually take these projects on. In a world seemingly filled with long-term investors, we just don’t have enough long-term capital. And to figure out why this is the case, I think we should take a hard look at the incentives we are creating among our asset managers. A fee is nothing more than an incentive; it is something that motivates an individual to perform an action. But, sadly, fees and costs remain an afterthought for the grand majority of underresourced Giants. How else do you explain the Securities and Exchange Commission investigating 400 private equity GPs and finding that “a majority of private equity firms inflate fees and expenses charged to companies in which they hold stakes”? A majority? Wow.
How does this happen? How do we end up with an asset management industry that’s adept at hiding fees and costs and yet is borderline incompetent at actual long-term investing?
It’s not just that we don’t understand the incentives; it’s that the asset owners themselves are woefully underresourced. The smug asset manager from the first paragraph is actually right: Pension funds in middle America probably couldn’t do what he does. But that’s not because what he does is all that hard. It’s because the pension funds’ laughably limited resources prevent them from mounting a credible challenge. The U.S. pension system serves asset owners up to asset managers on a platter.
Asset managers like to believe they are geniuses who have captured so much wealth because they are champions of the free market. But in reality they are the recipients of a gift made by government policymakers that couldn’t stomach what was actually needed to build an effective pension industry. Nobody with business acumen would run a pension fund the way we run them today. This is not a free market. The asset management industry has been rigged by the politics of pension funds.
Consider this insanity: The financial industry is so reliant on these so-called government handouts that when a government does take the step of building a professional investment function, newspapers present it as “bad news for money managers and consultants hoping to grab a share of those assets.” Think about that for a second. What’s unarguably good for a government and its citizens is bad for finance intermediaries? Yes, people, this is a reminder of how much profit Wall Street earns on the backs of unsophisticated clients.
So let’s call it like it is: The financial markets we’ve created were corrupted by the influence of politics right from the start. And so today’s intermediaries are no different from corn farmers in that they are benefiting enormously from governments’ spending choices. And, like the farmers, the market distortions resulting from these government choices are creating all sorts of negative externalities. Let me just walk you briefly through some of the distortionary effects of the excessive fees and costs:
- Labor Market: By overpaying certain asset managers (e.g., hedge funds), we as a society are telling people that you can make real money through the adroit playing of short-term, zero-sum games. We compensate for this behavior even though it is not creating real value in the economy. In the past ten years, how many people have graduated from a top-ten business school and gone directly to work for a public pension fund in the United States? Are there any graduates who did? Conversely, how many Ph.D.s in chemistry or physics have been sucked into hedge funds?
- Economies of Scale: When people look at insourcing or outsourcing decisions, they often look only at the costs and benefits at a single point in time. They don’t think about future periods where the costs paid to external parties would allow economies of scale to accrue to those external parties. By ceding capabilities to the private sector at one point of time, you may be relegating your organization to a disadvantageous negotiating position in the future.
- Risk Quantification: Fee structures have the potential to dampen the true volatility (risk) of certain asset classes, which means Giants may be misunderstanding not only fees and costs but also risks. In the past decade many pension funds thought they were buying infrastructure via GPs. Upon further investigation, however, they realized that they’d bought an infrastructure-labeled private equity compensation structure. And, as such, the GPs were buying infrastructure with too much leverage to try to reach their carry. It didn’t end well.
- Organizational Resourcing: In a recent Wall Street Journal article, the resourcing issue is laid out explicitly: “[T]he world’s largest investors, including pension funds and sovereign wealth funds, are seeking new ways to invest in private equity to avoid the supersize fees.” In other words, after seeing the size of fees paid to managers, some pension funds have decided to develop internal capabilities to do things in more cost-effective ways.
So let me sum up here: I’ve spent a decade looking for a silver bullet that will convince pension fund boards of directors to take the professional competencies of their internal teams seriously. I’m increasingly convinced that the only thing I can do to get the base of our capitalist system to professionalize is to show boards and indeed sponsors the true cost of financial intermediation. Why do I care about pension fund professionalization? As I’ve said, I genuinely believe that we will need asset owners to be more sophisticated if we are to have any hope of saving capitalism from endemic short-termism and rent seeking and if we are going to unlock the capital we require to finance critical projects.
So if you’re an asset manager who has children who will inhabit this earth in the decades to come, go easy on me. I’m trying to save this planet . . . probably from you. And that likely means implementing militant fee and cost transparency as a mechanism to drive professionalization of asset owners and more long-termism among managers.