"The Decline and Fall of Fund Managers"

Jason Zweig at the Wall Street Journal's The Intelligent Investor:

Active fund management is outmoded, and a lot of stock pickers are going to have to find something else to do for a living.

The debate about whether you should hire an “active” fund manager who tries to beat the market by buying the best stocks and avoiding the worst—or a “passive” index fund that simply matches the market by holding all the stocks—is over.

So says Charles Ellis, widely regarded as the dean of the investment-management industry.

Stock picking “has seen its day,” he told me this past week, as assets at Vanguard Group, the giant manager of market-tracking index funds, approached $3 trillion for the first time. “With rare exceptions, active management is no longer able to earn its keep.”

If he is right, hordes of portfolio managers will eventually be thrown out of work—and financial advice could end up cheaper, better and more plentiful than ever before.

Mr. Ellis, 76 years old, is revered among money managers. He is the founder of the financial consulting firm Greenwich Associates, a former adviser to Singapore’s sovereign-wealth fund, the author of 16 books and former chairman of Yale University’s investment committee.

In an article in the latest issue of the well-respected Financial Analysts Journal, Mr. Ellis argues that fund managers equipped with sophisticated analytical tools, electronic trading and instantaneous access to news are engaged in an arms race resulting in a kind of mutually assured destruction of outperformance.

The faster and smarter each manager becomes, the more efficient the market gets and the harder it is for any manager to beat it. As a result, he writes, “the money game of outperformance after fees is, for clients, no longer a game worth playing.”

No one gave a hoot about fees in the 1980s and 1990s, when 2% in fund expenses barely made a dent in the 18% average annual returns of U.S. stocks.

But since the beginning of 2000, stocks have returned an average of just 4% annually. A 1% fee is a quarter of that return.

Fees will come down because they have to.

And that, Mr. Ellis warns, will lead to “a wave of creative destruction” comparable to the changes that swept through the steel industry decades ago.

“Part of me thinks he’s right, part of me doesn’t want him to be right,” says Theodore Aronson, an active manager who oversees $25 billion in institutional assets at AJO in Philadelphia....MORE