As an analogy to what the fund management sector looks like, one can compare it to the golden shiner, a small, unremarkable fish that moves in shoals and prefers spending time in shady, dark waters. Individual golden shiners are oddly bad at finding shadows. This was demonstrated by Iain Couzin, a Princeton University researcher who placed an individual shiner in a pool with a regular pattern of shadows. It could not navigate its way to the darkness. It was so poor that it seemed to find shadows only by chance.
However, shiners tend to do two things while wandering around aimlessly; they swim together and stop when they find a shadow. If a fish found a shadow it would stop moving and its neighbours would do the same. This is how the rest of the shoal found the shadow. Even though each fish is remarkably bad at discovery, a large group was very good at it. It’s an efficient system and an example of the wisdom of crowds in nature.
This system is not only found in nature but in the modern world too. For instance, the wisdom of crowds is a well-covered behavioural finance topic. Whatever your investment approach or philosophy, we should be able to agree that a wide range of views, research and perspectives add value to the industry. More independent voices inject fresh insight and opinions into the discussion which leads to better price discovery and more efficient markets. This has been a particular strength of the South African industry; over many decades new firms with unique identities have added their perspectives and views. Certainly, the industry as a whole would be in a worse off state without new firms entering the industry. Up to about 10 years ago, there has been a constant flow of new firms. Many of whom were considered upstarts and underdogs, and now form “the establishment”.
Back then the industry created opportunities and incentives for the entrepreneurial spirit to flourish for founders of these firms and ultimately it was investors that benefited.
Show me the incentive and I’ll show you the outcome – Charlie Munger
Unfortunately, things have since changed. While lots of attention has been focused on narrowing opportunities in South African markets, what has slipped by unnoticed is how the flow of new firms into the industry has declined significantly. We believe there are many reasons why almost no new entrants have entered the sector recently. These include high startup costs, large corporate remuneration packages and increased specialisation.
Full disclosure, I am the founder of a small asset management firm, so my bias is to say that clients are unwilling to use small firms.
This, in my opinion, misses the larger point that it is easier to ignore small firms if there are so few of us. Rather, the problem is deeper and more structural than a current preference.
We are amidst the consolidation of the industry as the stream of new firms dwindles and the average age of owner-run firms spans multiple decades. This is a fundamental change to the ecosystem that has developed, flourished and allowed clients to meet their investment goals, over time. Investors and advisors should be concerned; the path we are on could resemble the old days where the only options were products from a small number of market behemoths with pricing power and misaligned incentives.
An unlikely group has emerged in the face of increased market concentration. Small black-owned firms that were launched about 10 years ago. These firms began with early support from institutional investors looking to expand representivity within the industry. The founders were typically young(er) fund managers with a good track record although the current age of these firms means that their leaders are now veterans of several market and business cycles. These are not startup firms anymore but established small businesses. Their longevity also means that their track records bear scrutiny and many have award-winning funds. Irrespective of their success, this group has added an independent voice to an industry that is unfortunately moving in the opposite direction. If this group fails, who could blame new rising stars for climbing the corporate ladder instead of building something new?
Despite many of these firms having long and successful track records with institutional clients, they have not gained traction in the retail market. Small firms have always struggled in this area. I believe that this change in the landscape means that the interests of small fund managers, investors, IFAs and DFMs have now converged. Investors need a well-functioning financial ecosystem, from minnows to apex predators, yet currently, we are seeing virtually no new entrants. Fund manager consolidation means that DFMs and IFAs will struggle to differentiate their investment strategies and will have few options if or when they need to make changes. Consolidation is great for the profitability of large firms but is unlikely to serve the rest of us well.
The call to action is very simple: look at your portfolio mix and ask if your fund managers represent your long-term best interests or if the selection is contributing to the erosion of the fund manager ecosystem? I appreciate why it feels safe to pick a familiar name, but it is far more prudent to thoroughly evaluate all managers with the right skills across the sector and not just the ones with billboards on the highway and banners at the airport.
Fund Managers
Manager research must be fit-for-purpose and not tinged with old biases. It should no longer be acceptable to simply hide behind the weak platitude that an experienced fund manager is “not ready yet”. Nor should a firm’s credibility be dismissed because it requires extra work to explain who they are and why they may be the right option for a client.
Charlie Munger said, “Show me the incentive and I’ll show you the outcome”. The current approach perpetuates an environment without an incentive for anyone to start a new firm. The result will be a scenario where we all rely on the good nature of the very large.
