The funds management industry is in trouble. Of that there is little doubt. Head count among the major managers has been cut by at least 10 per cent, according to a Watson Wyatt report last month. Among hedge fund managers, the head count is down an average 20 per cent. And the worst is yet to come, from the funds managers’ business perspective. The Watson Wyatt report says that funds managers started the year with a revenue ‘run rate’ down at least 30 per cent on the start of last year and they were looking to cut total costs by 20 per cent.

Hedge fund managers are faring even worse. For many, this year is about survival. For super funds, the economic health of their service providers is important. It’s supposed to be a long-term investment portfolio, so the sustainability of the businesses which manage that portfolio is important. When businesses go into decline their customers invariably suffer too. Watson Wyatt believes that the possible ill health of many active managers is cause enough for funds to revisit their view of the passive versus active split.

Passive versus active is already the biggest decision facing super funds at the moment, without factoring in manager risk. AustralianSuper has created enormous interest in the market with its decision to sack 20-or-so active managers and index half of its Australian equities portfolio. Both sides of the argument are credible. If the broad markets have fallen 40 per cent or more, then the law of mean reversion says that they should rebound by a significant amount in the medium term.

So, if broad markets are going to come back at least 20 per cent or more, why should an investor spend any effort trying to eke out an extra 1-2 per cent of alpha at high fees? But, according to most observers and certainly most active managers, we are currently in the best environment in living memory for stock picking. Investment banks’ proprietary trading desks have exited the market, leaving hedge funds with a new range of opportunities, provided they can get the credit for leverage.

And a whole new range of distressed debt and equity funds have sprun up to take advantage of the troubles many companies are finding themselves in. According to Watson Wyatt research paper, the ad valorem fee basis upon which the industry is centred means that profits will remain under pressure as long as market returns and new inflows remain low and while there is little appetite for raised fees.

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