Over-regulation poses the single biggest threat to the asset management industry, according to Eric Syz, chief executive of Syz Group, who said that rules introduced with good intentions often end up penalising the very people they are supposed to protect.
Syz (pictured), who set up the eponymous group in 1996 with the principle that its managers would run clients’ money as they would their own, described over-regulation as a worldwide problem. He added that by trying to over-protect the individual, regulators have a habit of introducing rules that are so stringent they end up bogging down the industry to the point it can no longer add value to the end consumer.
“Hence they are basically destroying the industry because the regulatory aspects eat up a lot of the cost of doing business, with the result that the consumer can basically only index invest,” he said.
“They will have no more research to discriminate where to put their money. Nobody is going to pay for the research, so why would I produce it?
“And so I think that very often when the regulator steps in, with very good intentions, it often has the contrary effect. And I think the consumer will suffer.”
Syz said regulators appear to have the aim of slashing fees to zero and are promoting the use of passive funds in the belief this will help them to achieve this target. However, the chief executive said this is creating an entirely new set of problems that will have the biggest impact not on the active funds that groups like his manage, but on the end consumer.
“Now the truth is that passive investments don’t have zero fees,” he began, “but if you believe they will continue to dominate the investment world, there will be no more discrimination. In other words, companies’ prices will no longer go up or down as a result of how well they are doing. Passive investment will simply invest according to what the market cap is.”
“What that leads to is a great opportunity for active investors to make a difference by buying or selling those companies [based on how well they are doing], which also leads to enormous volatility because there will be fewer actives with very little money to actually influence those stocks.”
Chris Wagstaff, head of pensions and investment education at Columbia Threadneedle, echoed this view, saying: “There is a strange paradox where passives can’t survive without active funds and actives do better when passives dominate.”
”Once one-third of the market is in passives, it becomes less efficient because companies are not as well researched and there are more opportunities for active managers. The US is approaching one-third in passives, so it is close to a tipping point.”
“Also, passives tend to do very well in a rising market, but they are susceptible to momentum risk and concentration risk. They become forced buyers of market favourites which leads to concentrated portfolios.”
“They also can’t avoid a downturn in markets – when a bull market turns into a bear one, you find that they have bought a lot of the stocks that have become overvalued and are now leading the market down.”
Much of the gains in efficient markets where passives do well have been driven by certain sectors such as technology, and passive houses have reacted to this by introducing low-cost thematic funds that only buy stocks in certain sectors. However, Syz said that just because these funds have low fees, they are not necessarily adding value to the end consumer.
“The end consumer still has to make a decision ‘do I want to be in or out of technology’ so you are basically pushing back the decision-making process to the individual and no longer offering advice and saying, ‘[the active manager] will get paid for making that decision’.”
“It is just an easy way for them [passives] to continue their business case,” he added.
Not everyone in the financial services industry shares Syz’s concerns about the growth in regulation however. Speaking on the 10th anniversary of the start of the financial crisis, Steve Eisman, senior portfolio manager at Neuberger Berman and the inspiration for the character played by Steve Carell in the film The Big Short, said: “Pre-crisis, the position of regulators – which was the longheld view of Alan Greenspan – was basically: 'We trust you know what you are doing, so carry on'.”
“This is not the position now. It is more like: 'We do not trust you know what you are doing and we are going to watch you like a hawk'.”
“The system is now heavily regulated and closely watched, which I believe is right. The world is a very different place to what it was pre-crisis. For the first time in my working life, which is more than 30 years, I would regard the financial system as safe.”