The Rapid Evolution of Asset Management Services
Traditionally, the goal of asset management has been to provide a portfolio that will slightly outperform the market as a whole. For decades, most "professionals" with all the training and tools at their disposal have failed to beat the market indexes.
At times, specific mutual funds have been ahead of the curve for a few years at a time, but then fell behind (just as people bought into them, thinking the history of performance would continue). And so, in the log run, the vast majority of funds and managed portfolios have been losers.
Aside of speculation, this failure to perform is due to the cost of churn in actively managed portfolios generates expenses. He goes into detail about how the impact is calculated, but the net result is that active management eats 1.37% of total returns, making it even harder for an actively managed fund to beat the markets.
Another way of looking at the situation is that mutual funds, as a whole, are a sample of the stock market - some will earn higher than average, an equal number will earn less than average, and the average one will earn exactly the average return ... but all returns to investors will be "less fees."
Asset Classes
The current trend seems to be to seek investments of specific classes - small cap and large cap, growth and value - and manage a fund or portfolio to contain a blend. Even this has not been optimal, and falls short of indexed fund returns.
There are statistics that show some of the riskier investments (small caps and value stocks) have outperformed the S&P 500 - but the margin to which they exceed the index is shrinking. A detailed analysis is done, but the net result is that a managerusing this strategy has roughly a 10% chance of exceeding the return of market indices by a sufficient amount to cover the additional costs of active management.
The Future of Portfolio Management
As a result, financial planners are increasingly buying into low-load funds that track market indices rather than trying to pick funds or stocks that will outperform the market. While better returns remain of important, the key differentiators among funds that track the same indexes are generally costs (fees) assessed by the fund.
It is also suggested that financial managers can choose among indices. There are several indices for the domestic stock market, another set of indices for foreign ones. A financial planner may choose what proportions of which index funds a client buys into.
EN: What strikes me as odd is that someone, somewhere, still chooses the stocks that make up an index. In that way, the organization that decides on the index is managing a portfolio of stocks that constitute the index - so what, really, has changed? The task of portfolio design is still being done, albeit more centrally, by scholars who do not receive direct compensation.
For certain clients (due to age, wealth, risk aversion, or tax status), the choice is between index funds, bond funds, and municipal funds. But again, there is little to differentiate the funds of one company versus the funds of another, or any financial analyst's "skill" at selecting funds or individual securities.
The author suggests that this trend has already started: individual investors have learned the hard way, and are getting into index funds, and more mid-range clients are moving from managed portfolios to funds. There are a dwindling number of individuals for whom a custom portfolio of securities is built, and this is often done by "boutique" shops or small divisions in the larger brokerage houses.
Beyond Portfolio Management
Since there's less to be made by actively managing portfolios or helping clients select mutual funds, financial planners are shifting the services they sell to stay in business. Consulting and counseling services - helping customers understand finance and manage their personal spending - have become a profitable line of business.
They are also doing a lot of hand-holding. The author provides some quotes from advisors who find that they are doing a lot of work getting clients to stick to an index strategy, even to keep their money invested in the financial markets, when the bear growls.
Of course, what is best for the customer is not always palatable to the customer, and this may be standing in the way of evolution: a customer may be more enticed to buy into a firm that offers an exotic-sounding solution rather than going with bland old index funds. In the long run, they'll learn the hard way.
The trend for now is to herd the customer into index funds, or assemble a collection of securities that, while exotic-sounding, combine to come close to the index (if you buy stock in the 30 companies that make up the DOW, you have effected an index fund). It may even be necessary to put some proportion (preferably a small one) into actively managed funds to appease the customer's need to feel you are doing something to outperform the market.
EN: This seems a rather deceptive practice on the surface, but it may constitute acting in the client's best interest to the degree that the client will permit.
The author marvels at the vast amount of information about financial markets being made available to the average individual, mainly by way of the Internet. He sees a separate line of business in "information management" - a metaservice in which a firm will sift and filter the vast amount of information that is available daily to provide a more concise and intelligible subset of the financial news. His specific suggestion is an editorial board that publishes five or six articles a month by consolidating this information and filling in some of the gaps.
Given the large percentage of the population that is aging, he also sees an opportunity for growth in a service that has traditionally been fairly small: helping individuals manage their withdrawals from their investment portfolio, and managing that over time as life expectancy increases.
He cites that advisors have traditionally been too conservative in withdrawals, preserving the hoard of investments and making clients live on less than they could have actually withdrawn. The traditional figure is 4% per year - and he shows that a person who retired in 1970 would be living on a meager $40,000 per year while their portfolio, still invested, grew to $11 million.
Clearly, while there's a need to be frugal in case of market downturns, a much better balance needs to be struck. The author shows some of the work done in this area and some calculations he's done on his own, and there's a wide range of if-then scenarios.
It goes into a lot of detail about various tactics - but in the end, it's clear that there is no one winning theory for all situations, so, this will need to be managed and planned on an individual basis.