Are Active Management Fees Too High?

The potential payoff from active management has waned over the past 60 years, but the price of active management is at or near its all-time high. What does this seeming paradox imply for the future of investment management? Markets appear to have become steadily more efficient during the past several decades. Nevertheless, and notwithstanding evidence that active management fees are, on balance, wasted, the price of active management has risen steadily over the same period. The most likely explanation for the rising price of asset management appears to be the phenomenal growth of investable assets that occurred during the extraordinary era of the 1980s and 1990s. Investable assets increased by more than 1,100 percent between 1980 and 2004—from $7.5 trillion to $87.2 trillion—making this quarter-century the Great Era of Asset Gathering for the investment industry.Are investment management fees “too high”? Using a model that relates the likelihood of investor success to manager skill for various levels of fees charged, I conclude that, for a large swath of the investment management business, fees are implausibly high. In the absence of a continuation of the extraordinary growth of “assets-to-be-managed” seen during the past 25 years, I offer this forecast of the future: Active management will continue to lose market share to indexing.Downward pressure on investment management fees will be evident for the first time in history, and many investors will shift from high-priced active products to lower-priced ones as they come to recognize that high fees sap the performance potential of even skillful managers.A new market segment of investment management will develop. Although it will have many of the operational features of hedge funds, it will be characterized by greater transparency than is characteristic of hedge funds and pricing in this segment will be more like that of traditional institutional investment management.