Chances are that most people reading this haven’t even heard of Richard Woolnough. But over the past two years he’s earned more than £32 million. No, he’s not a Premier League footballer, nor a Hollywood star. What does he do? He manages other people’s money.
In fact, Woolnough’s remuneration for running M&G’s Optimal Income fund, is not particularly exceptional. Average annual pay for those that made the Forbes list of the 25 highest-earning hedge fund managers in the US in 2014 was a staggering $972 million (£682 million).
So how did fund managers start earning A-list salaries? A new book I’m currently reading, Investment: A History by Norton Reamer and Jesse Downing, suggests there are two main reasons.
First, the amount of money that needs to be managed is soaring. Millionaires have always provided rich pickings for money managers and their number is growing fast. But, as global prosperity increases, a much wider client base is developing. In the US, for instance, retirement savings grew from $368 billion in 1974 to more than $22 trillion by 2014—a five-fold increase in assets relative to income.
The second reason why fund industry salaries are so high is that fees are linked to the value of the assets. Because the cost of managing £100 million is little more than the cost of looking after £10 million, fund managers have effectively benefited twice — first, from the increase in savings and, second, from the huge rise in asset prices since the 1980s.
In his recent post How the Investing Industry Could Change, Morgan Housel of The Motley Fool suggests four additional reasons why fund managers are so well compensated:
- customer ignorance of fees;
- regulatory advantages at large institutions;
- high barriers to entry protecting incumbents; and
- success of first-movers inflating the expectations of current customers.
But whatever the causes of salary inflation are, money management is effectively the same job now as it was in the 1970s, when fund manager pay was on a par with most other professions.
As Warren Buffett once said of financial professionals, “They work hard, they’re bright, but they don’t work that much harder or are that much brighter than somebody that is building a dam some place, or a whole lot of other jobs”.
Whenever I write about fund manager pay, there are always people who say it’s none of my business and that it should be left to the market to set the right level. Generally, I agree (hey, I’m an indexer, and I believe in markets more than most), but here is a classic example of market failure.
The evidence is overwhelming that, far from adding value to the investment process, fund managers, as a group, extract it. To quote David Blake, Director of the Pensions Institute at Cass Business School in London, in a recent article in the Financial Times:
“The average fund manager is unable to deliver outperformance from stock selection or market timing. A small group of star fund managers are able to generate superior performance, but they extract the whole of this outperformance for themselves via fees, leaving nothing for investors.”
Once again, all this serves to underline the need for greater transparency. Investors need to see — in pounds and pence — how much in total they’re paying for fund management, and how that compares to the actual value their particular manager is providing.
The industry, of course, knows all to well that, when confronted when this information, investors will desert active funds in their droves and rely on low-cost, passively managed fund instead. Transparency will also force active managers to reduce the fees they charge — and the salaries they pay their fund managers and other staff.
This is only what’s happened to almost every other industry. Why should asset management be any different?
Of course there will still be a demand for active management. But funds will need to prove their worth. Funds that can’t will fold — and those who’ve made a fortune managing them will have to find some other way of earning millions of pounds a year.
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