The $100 Trillion (Broken) Machine
“What transforms this world is — knowledge. Do you see what I mean? Nothing else can change anything in this world." - Yukio Mishima
When I decided to take a break from the asset management industry earlier this year, I did so because in my view the industry as a whole is not what it portrays itself to be.
I got in the industry with the textbook romanticised view that asset management was the economic apparatus which is mainly responsible for efficient allocation of resources or capital. However, after almost six years in the sector, my observations led me to conclude that the industry was not what the textbooks were preaching.
Firstly, the asset management industry is now so big that it is no longer serving an economic function. Rather, the economy serves this sector.
Moreover, although there are some great firms to work at, most of the sector has the same corporate culture: shallow, fake, barely meritocratic, rigid in its approach to new ideas, impersonal, dominated by a lack of real opportunities and full of tick box exercises that make the experience dull and standard, at times even causing anxiety and a lot of stress that rarely is worth enduring.
On top of this you have, especially in the hedge fund sector in which I worked for over two years, this obscure obsession with reaching the “billion dollar club” that encoruages too many managers to gather assets as fast as possible just to be mentioned on a list that nobody really cares about.
Not to mention the useless conferences and meetings and the thousands upon thousands of Gigabytes of data in the form of presentations and charts that most asset managers publish as “cutting edge” research, when in reality they are pretty much saying what the other firms have said but branded in their own colours with one or two paragraphs that differentiate the texts.
I went further in my analysis and claimed that the actions of policymakers - these are people who are supposed to make the “rules of the game” and ensure a competitive and fair marketplace - have enabled the industry to get too big, too inefficient at its role, too standardised and too powerful.
Through what actions has this happened you may ask. Primarily through two channels: monetary policies pursued by central banks (this is what gives the forever growing flow of capital into asset managers’ products which they launch every week or so) and the dynamic between lawmakers, lawyers and lobbyists (this is what protects the “information edge” of many managers).
These two forces have ensured that the process of globalisation - which here simply means the eradication of borders for capital flows and for the movement of certain people- has benefited the industry a lot.
As a result, everyone owns a bit of every asset, has more or less the same view on important market and economic issues, forms a consensus on geopolitics and overall pretends that we are living in the late 1980s when the liberal, capitalist democracies held an innocent view of other rising powers - Russia, China, Iran etc. - forever hoping that they will “come around” and open up their markets, while wilfully ignoring that what defines our twenty-first century world is not co-operation but ruthless power plays pursued in the name of private interests always portrayed as “public interests” or “equality”.
Of course, not every single firm or person working in the sector is like this: I met a few wonderful people over these years. But for the most part, that has been my experience in the sector.
This week I came across a recent report from Boston Consulting Group (BCG), one of the world’s most elite consulting firms, which reaffirmed some of my concerns, especially at the big picture level.
The publication is called “The $100 Trillion Machine” and explores the growth of the asset management industry globally. The first exhibit of the report shows the growth of the assets under management (AUM) between 2003 and 2020, highlighting that the industry has seen an 11% increase in AUM from 2019 to 2020, passing the $100 trillion mark and reaching $103.1 trillion.
However, this chart tells you nothing that matters about this industry: these numbers are meaningless on their own. So let’s provide some context.
The data below comes from the following sources: BCG, World Bank, PwC, BIS, Tower Watson and CrossBorder Capital. For the “Global Financial Assets” I had to estimate to the nearest trillion because the data I have comes in the form of a stacked chart without data labels. However, I can provide the work to anyone who wants to check how I did the estimation.
The first chart shows the total AUM of asset managers relative to world GDP ($ trillions) and the second chart shows the same thing but as percentage (i.e. global AUM as % of world GDP).
As an aside, from the second chart you can see that the last time the asset management industry has reached above 120% of world GDP was prior to the 2007-2009 financial crisis. Today, we are at the same point again - is a correction due?
I hope so. Any system that grows too big is full of inefficiencies (frictions), like huge bureaucracy that have to be cleaned - it is absolutely insane through how many hoops you have to jump to get something done in a large asset manager today: even a mere blog can take a week or more to get published (after it was written) due to “compliance”.
However, the BCG data looks incomplete if we look at the more thorough data set from CrossBorder Capital on “Global Financial Assets”.
A lot of that “financial assets” is debt (about half of it in 2020 - i.e. close to $130 trillion). However, the composition of these assets is a different discussion.
The bottom line is clear here: the asset management sector is bigger than the economy - even if we just take into account the BCG data.
This is not the only issue here. The concentration of this broken $100 trillion machine is blatantly anti-capitalist and screams “lobbying!”: how else are these monopolies forming if not by being allowed by regulators?
As of now (early August 2021), the world’s 10 largest asset management firms manage a combined total of over $40 trillion AUM. That is 40% of the global industry’s AUM, using the BCG data. I am not going to give you the whole list but only one figure - this is how mental the situation is: the monopoly is so vivid that only one data point is enough.
One firm (BlackRock) manages nearly 10% of the industry’s assets and a bit over 10% of the world’s economy. To me, this level of monopolistic power should have never happened. But it did happen and it happened with the help of regulators in conversation with lobbysts and lawyers and “industry representatives”.
This in effect creates huge barriers to entry for new managers who might be more talented and more skilled than the ones who are currently dominating the market. These insights aren’t really captured in data sets - do you think you are allowed to receive information that is important?
These insights are developed while working in the industry. Ask around how much the Compliance departments have grown in recent years (decade or so) or the breakeven costs for smaller and newer managers (with less than $250 million AUM) and see what they say.
You may at least think that, ok, this is a too big of an industry with a concentration of market power - but it is at least efficient at what it does. Yeah, not really.
The asset management industry is now an asset gathering industry, broadly speaking. Between 2019 and 2020, the global AUM grew by 11% while the profit of the industry only by 1%, according to BCG which reported this rather pathetic development with the usual PR positive spin: “Profits Increased by Only 1% Despite Strong AuM Growth”.
The industry is simply too big to be profitable. Let’s take a more specific example: the hedge fund sector.
Hedge funds’ AUM grew from a few billions in the 1980s to $3.6 trillion in 2020. These managers are supposed to deliver at least low double digit (i.e. 10%) of returns to their investors. Not so fast. The average hedge fund has delivered below 10% for nearly a decade, with many returning negative figures. The data below shows this and it comes from Aurum.
I used to create quarterly chart packs with hedge fund performance from various research houses (like HFRI and Preqin) and if you knew how many hedge funds were struggling to perform above AAA government bonds…Last time I checked the data from Preqin, there are 7,000 hedge fund managers worldwide and only very few deliver about 10% returns, not to mention that many did nothing akin to hedging during the COVID-19 market meltdown (i.e. during a time of crisis, many of these funds did not do what they said on the tin).
Ray Dalio from Bridgewater went on a panel in 2019 (or late 2018), when the hedge fund industry was just above $3 trillion and said that 10% alpha per year (i.e. $300 billion in profits) was not realistic and the reason was: the industry was too big: too much money flew into these products, mostly due to “institutionalisation” (in my opinion).
Similar things can be said about index funds, ETFs, pension funds and virtually any part of the sector: overall, the industry is profoundly inefficient, too big and with too much of the same thinking about markets, the economy and geopolitical events. People that think that diversity comes from being a man or a woman, black, white, yellow or any other skin colour are morons: diversity only comes from thinking differently and nobody can think differently if everyone is trained the same way, learns the same things and has broadly the same view on the economy and markets.
You’d be surprised just how quickly and entrenched a consensus is formed in the industry and the managers or analysts that do have a different (especially radically different) perspective on things are so rare that you remember their names. If you want to see this for yourself, visit the websites of big asset managers and read their reports: how similar they are in their presentation, language, their data and their takes / conclusions?
The solutions required are radical: shrink the sector, close down the central banks, fire the corrupt policymakers, reduce the number of lawyers and lobbyists, encourage critical and different thinking (no matter how crazy it may sound) and - the most important thing of all - educate more people on financial matters.
How come we reach adulthood (here in the West) with virtually NO knowledge of what the City (London) or Wall Street (New York) really do, of how the monetary system works, of what is our money and where does it come from, of how pensions work and so on? The answer: by design.
The “average person” has as much responsibility in forming this bloated sector as the people inside it. For example, in the UK, 98% of people that have a defined contribution pension scheme are invested in a default fund. In other words, 98% of DC pension fund contributors in the UK either do not care or do not know that they should care about where their savings are invested.
Despite all of this, I still like asset management: at its best, it is strategic thinking and it could be a great sector to work in, if you find the right firm and team. In fact, there are places in which you can do wonderful work. In my experience, these are often boutique managers that have a small but loyal client base and a united team, which are aware of the above weaknesses and the risks they pose and which look at the world in terms of generations not quarters.
You can also find good places in larger companies, depending on the department’s head: culture and team chemistry are everything. Usually this happens when the guy / gal running the department has enough of a reputation that he / she is regarded “that crazy” person who “does their own thing” and can oppose the status quo of the industry to some extent.
If you want to join the industry look out for the above inefficiencies and seek to work with people who share your values and vision: do not sell out, because the rewards are not worth it.
That’s it for this week. Thank you for reading.
If you want to read my latest short stories, you can check them out here:
The River - inspired by Peter Wessel Zapffe’s essays, The River follows the life story of a creek that over many years grows into a river, clean and healthy. Until one day when development and progress came.
LA Pine Trees - a short story about perception of time, aesthetics and meaning.