Asset management barbell getting heavier

Barbells have been around a long time.  According to historian Jan Todd, a Boston area strong man named George Barker Windship was the first to patent the now ubiquitous variable-weight barbells found in most gyms.  That was 1865.  But the first use of the term “barbell” was in an obscure 1870 British book called “Madame Brennar’s Gymnastics for Ladies, A Treatise on the Science and Art of Calisthenics and Gymnastic Exercises.”

Today, the term “barbell” is routinely applied to anything that maintains its balance even though its bulk is distributed mainly at two ends.  Take, for example, the asset management industry.  As the Financial Times reports this week:

“Things are looking good for the asset management barbell thesis Morgan Stanley (AMEX:MWD) first put forward five years ago. This suggested traditional asset managers would lose out as money increasingly shifted to cheap passive strategies on the one hand and alternative investments and high return specialists on the other.”

As we’ve reported extensively on these pages, the big winners in the asset management industry have been alternative investments and ETFs – both of which represent the constituent elements of any traditional active fund – the variable weights at each end of the proverbial barbell.  The Morgan Stanley report covers the European asset management industry and clearly illustrates this trend.

The chart below from the report shows that passive (ETFs) and high-alpha (short-extensions, funds of hedge funds etc.) are growing the fastest.

As one FT reader pointed out, the barbell phenomenon has also been reported by others.  In a 2006 report by IBM, that company wrote:

“The separation of Alpha from Beta is expected to shift profit away from traditional long only active funds toward the extremes of unconstrained Alpha-generating investing (more volatile pools, such as certain types of hedge funds and private equity) and passive investing (index funds, exchange-traded funds and certain types of derivatives).  Firms that understand how to best match assets to liabilities – and, over time, can execute on that understanding – will attract and retain the most assets, from both institutional and retail investors.”

While IBM also predicted growth at both ends of the barbell, it also warned that alternative asset profit margins would be squeezed at the same time…

Well, IBM may have been right.  Despite firm pronunciations that hedge fund fees would never fall, the Wall Street Journal reported today that several hedge fund companies were offering investors a fee-cut in exchange for their continuing patronage.  Now this isn’t totally new.  Regular readers may remember when we raised an eyebrow at Goldman’s one-time fee cut last August after one its flagships sailed into a category 5 hurricane.  But this new round of discounting arises not from a bad month, but possibly from something more fundamental…fee competition.

What’s particularly interesting about these recent fee cuts isn’t the actual rates (2-and-20 may be the “industry standard”, but research reveals the average is closer to 1.5-and-15).  It’s the fact that incremental fee cuts have been offered to investors depending on their willingness to lock-in their capital.  In a sense, these firms are buying liquidity.

In any event, while Reuters pointed out today that several mega-funds have “shrivelled” so far in 2008, Investment News nonetheless trumpeted that “Hedge fund assets hit $1.7 trillion” in their coverage of the same industry report.

Meanwhile, at the other end of the barbell, State Street said just last month that:

“Despite a sharp decline for US equities in the first half of 2008, investors continued to increase their appetite for ETFs, which is a testament to the increasingly vital role ETFs play in a growing number of portfolios and strategies…”

Too bad old George Barker Windship didn’t also copyright the term “barbell”…

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