Barron’s Focus on Funds: Asset Managers Should Impose Capacity Constraints

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  • In a recent interview, the CEO of AllianceBernstein Holding, Peter Kraus, told Bloomberg that he believes the entire active management industry has grown too large and may need to shrink by one-third if active managers want to beat industry benchmarks.
  • He comments that assets in actively-managed products grew significantly for an extended period of time without much restraint and the subsequent performance of active managers (relative to their benchmarks) largely disappointed.
  • He attributes the poor subsequent performance to the actively-managed portion of the asset management industry being too large and the diversification of holdings as active managers see an increase in the amount of assets under management. He believes the combination of those two factors has led to a decrease in the ability of active managers to produce the good results that contributed to the growth in assets in the first place.
  • Kraus believes that every active manager should place capacity constraints on themselves.

Our Take

  • Although Kraus spoke in generalities about the active management industry that were admittedly guesses, we agree with his underlying point. At the individual portfolio level, extreme asset growth or “asset bloat” impairs the ability of an active manager to beat its benchmark.
  • We have witnessed the negative impacts of “asset bloat” in a number of actively-managed products over our careers. Eventually “asset bloat” tends to force active managers to adjust how they manage their portfolio and the securities they select for the portfolio. This may include changes such as increasing the number of holdings, reducing the percentage of assets invested in their highest conviction ideas, extending the time frame to enter or exit a position or increasing the market-capitalization of companies they target for inclusion in the portfolio.
  • In our experience, there isn’t a simple threshold where assets under management becomes too large. However, the amount of assets that an active manager can effectively manage without suffering from “asset bloat” can be understood through an analysis of their investment process, the market segment in which they invest and the underlying portfolio characteristics. For example, an equity manager with $10 billion in assets that focuses on large- and mega-cap equities would most likely be able to invest that level of assets with minimal impact on its intended portfolio structure.  However, if an equity manager with that same $10 billion in assets focused on small- and micro-cap stocks, it would have to significantly expand the number of equity holdings in its portfolio. Without an expansion in the number of holdings, it would be hard to establish meaningful positions in companies without greatly impacting liquidity, among a number of other factors.
  • We have a strong belief that “asset bloat” can adversely impact future returns. As a result, it is one of many factors that we closely monitor for our recommended asset managers. If we determine that a manager has taken on too many assets to manage its portfolio effectively and as originally designed, we will recommend that the manager be sold.