In the History of the Peloponnesian War, Thucydides — that guy you were forced to read in college history — wrote, “The strong do what they can, and the weak suffer what they must.”
His adage finds expression today in the power asymmetry between asset managers (the strong) and asset owners (the weak). While asset owners, like the people of Melos, might like to believe that they hold a position of parity with asset managers, there’s little evidence to support that.
This power asymmetry is clearly manifested in misaligned fee schedules and liquidity terms, and in the often infuriating passivity with which asset owners consume the products offered up by asset managers.
In spite of these “minor” inequities — which asset owners tolerate and perhaps moderate through private negotiations (i.e., side letters) and “strategic partnerships” — the elemental compact between owners and managers has remained firmly in place, reliant on the belief that asset managers would place their clients’ interests ahead of their own and act as good fiduciaries.
It appears this compact has been compromised.
As a brilliant young deputy CIO recently told me — without a hint of irony or disbelief — some of the “largest well-known, blue-chip hedge fund managers” have eliminated any reference to fiduciary duty from their investment management agreements.
And, perhaps even more Trumpian than President Trump himself, they are telling prospective investors that they will engage in activities that will not be in their clients’ best interests.
Furthermore, the deputy made clear that these asset managers consider that proviso nonnegotiable: There is sufficient demand for their products that asset owners either accept the terms or step aside for the next in line.
Here is the fullest expression of the imbalance between asset owner and asset manager. In renouncing fiduciary duty, asset managers are explicitly recalibrating the power structure of the owner–manager relationship to a position of extreme asymmetry: “I owe you nothing. You have no leverage other than investment. You are powerless in this relationship.”
This is a salesperson’s dream — and a CIO’s nightmare.
My anecdotal research supports this charge of asset managers’ refusal of fiduciary duty, with a small number of managers in the vanguard. It also reveals this to be a fairly recent phenomenon. Asset owners confirm that as recently as five years ago they could get just about whatever terms they wanted in a contract. Perhaps the wall of money from public funds into the hands of a few hedge funds and private equity and venture capital firms precipitated this change — but whatever the cause, this is a seismic shift in the power dynamic.
The seizing of this power by asset managers could be characterized as a rational commercial response to maximize the value of their businesses (such as, fiduciary duty is the ultimate portfolio constraint vis-à-vis the fundamental law of active management).
However, paraphrasing technology theorists Vasilis Kostakis and Michel Bauwens, this newly defined asymmetry creates and propagates an artificial scarcity of knowledge, subjecting innovation to contrived restrictions and allowing for profit maximization and capital accumulation. The result is both paradoxical and dramatic: While this power structure cannot produce the desired risk-adjusted returns net of fees, it simultaneously inhibits the development and deployment of new solutions that could meet the needs of asset owners. Put simply, the increase in these managers’ assets under management and their ability to act in their own best interests has completely failed to result in a corresponding uptick in innovation or in performance.
On the other side, asset owners’ acceptance of this extreme asymmetry is hardly rational because it provides, at best, access — a benefit that is incommensurate with the abdication of fiduciary duty (after all, it’s not like they are getting access to the Medallion Fund).
It’s important to recall two things: The asymmetry between asset owners and asset managers (even in its weakest form) is a relatively modern phenomenon, which can be traced to the late 1960s, when we saw the formation of the first independent institutional investment management firms and investment consulting firms (and the start of Institutional Investor).
Second, in base terms there are no institutional managers without asset owners.
Asset owners’ source of power is their ability to say “no” — to reject the status quo — coupled with their ability to allocate large sums of patient capital. My deputy CIO expresses his power every time he walks away from disadvantageously structured deals. But such discrete acts of protest will change nothing.
Actual change will require asset owners to be genuine, vocal advocates for their beneficiaries — individually, through acts of rejection of misalignment and transparent communication; and collectively, through active participation in asset owner–driven organizations seeking to reset the fulcrum in the balance of power (e.g., the Alignment of Interests Association and the Institutional Limited Partners Association).
In a word, asset owners need to act like the fiduciaries they are.
