The Australian Financial Review | 17 Nov 2010
By Stephen Shore
The funds management business is thriving. The worst financial crisis in living memory and consolidation inthe superannuation industry have done little to dent the number of businesses making a living from the Australian stock market.
According to Mercer Surveys, about 140 equities managers compete to invest Australians’ retirement moneyand personal savings.
Academics reckon this is far too many and the cost of competition is driving down investors’ returns.The competitive drive to outperform on investment returns dramatically shortens investment horizons andlowers longer-term returns, argues UTS finance professor Ron Bird in his submission to the Cooper review.
In an open free market, competition should drive prices down towards the marginal cost of production, hesays, but this effect is almost totally absent in funds management because managers compete on pastperformance rather than on price.
Bird argues that because active management is effectively a zero-sum game, aggregate retirement savingsare reduced at least 1 per cent per annum by the cost of playing the game. “For a manager to outperform bythe standard 2 per cent net of costs he must find another manager willing to underperform by 4 per cent.”
Frontier Investment Consulting chief Fiona Trafford-Walker says she is surprised there has not been moreconsolidation in the industry, but she points out that being a mediocre fund manager is still pretty lucrative.
“I think partly it reflects that you don’t need to raise a huge amount of money to run quite a good business,”she says. “There are almost no real barriers to entry, almost anybody can set up a shop and if you happen toswing it with a big mandate you’re off and running.”
Walker thinks the number of managers could be pared back by more than two-thirds to 40 or 50. “There areway too many managers in the Australian market,” she says. “The market is overserviced and, as the numberof superannuation funds start to consolidate and push harder on fees and terms, [super funds] will consolidatethe number of relationships they have.
Despite this trend, you can count on two hands the number of fund managers that have been taken over orshut up shop since the financial crisis. Cannae Capital was acquired by Investors Mutual in January becauseit was struggling to attract mandates as a small player. In May 2009, Alpha Investment management closedafter the industry super fund AustralianSuper redeemed a $345 million mandate. Other funds to havedisappeared include Rohan Hedley’s Hayberry, Platypus Capital Management, Gerard Eakin’s Manifest, ex-Colonial First State duo Greg Perry and Barry Henderson’s QED and Kerry Series’s DVA Capital.
Pengana Capital fund manager Rhett Kessler, who set up in 2008 and has just $20 million undermanagement, says a key reason bad fund managers survive is distribution.
Firms such as BT, AMP, Colonial and MLC allocate investors’ money based on the approved funds on theirlists, which are reviewed only every one or two years. To get on those lists and become a recipient of thosefunds’ flows is difficult, but by the same token it’s hard to get kicked off. Smaller funds with strongperformance often complain that the gate keepers who control where the money goes are generally quite slowto recognise new entrants.
Kessler says the market is more efficient at the small end of town. If the manager fails to perform, they won’tattract enough clients to reach critical mass. But because investment horizons are usually at least three years,a large fund manager could under-perform for a long time before it is held accountable.
“If you have good performance for a period and establish a good name you can live off that for many years,”Kessler says.
Walker says often the small fund managers who start up the boutiques tend to do better earlier on and canattract a lot of capital on the back of a new track record. Repeating that success once the fund has a lot moremoney under management can be a lot harder, but if two or three partners run a few billion dollars it’s a prettytidy business just on fees alone.
Bird says fewer agents and less destructive competition will force a sharper focus on members’ longer-terminterests, ameliorating the curse of short-termism and lessening its damage to the economy and to retirementsavings.
“With fewer opportunities, more appropriate compensation, and far less glamour, fewer people will be attracted to finance and investments and might just direct their talents to more productive sectors of theeconomy, adding real value by increasing economic growth.”
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