Working Paper: CEPR ID: DP6531
Authors: Gur Huberman
Abstract: Although established money managers operate in an environment which seems competitive, they also seem to be very profitable. The present value of the expected future profits from managing a collection of funds is equal to the value of the assets under management multiplied by the profit margin, assuming that the managed funds will remain in business forever, and that there will be zero asset flow into and out of the funds, zero excess returns net of trading costs, a fixed management fee proportional to the assets under management and a fixed profit margin for the management company. A profit margin of 30% seems empirically reasonable, but money management companies seem to trade at 2-4% of assets under management. Attempts to reconcile the two figures are not compelling, which is disturbing considering the centrality of the present value formula to finance and economics. Another computation suggests that holders of actively managed funds typically lose about 12% (18%) of their assets if they hold the fund for 20 (30) years, as compared with a loss of less than 3% (5%) for low-cost index fund investors for similar holding periods.
Keywords: managed fund; money manager; trading
JEL Codes: G10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Expected future profits from managing funds (G23) | Market valuation of money management firms (G19) |
| Assets under management * Profit margin (G11) | Present value of expected future profits (D25) |
| Market valuation of money management firms (G19) | Pricing discrepancy (D49) |
| Competition in money management firms (G19) | Profit margins sustainability (L21) |
| Fee structures on investor wealth (G19) | Mispricing of money management firms (G19) |
| Active fund holders (G23) | Loss of assets over time (G32) |
| Low-cost index fund investors (G23) | Loss of assets over time (G32) |