Why money managers are paid so much is a mystery

[scottish]

This article appeared in the paper today.  It was written in such an innocent style that I had to double check that I wasn't reading The Onion.

http://ottawacitizen.com/news/fp-street/earning-the-big-bucks-why-money-managers-are-paid-so-much-is-a-mystery/wcm/f429e329-c9a8-4e5f-948a-7ac58a19a899

Why do workers in the financial industry get paid so much? There are many possible explanations, none of them completely satisfying.
What are all those people getting paid to do? One possible answer is that they’re getting paid to earn market-beating returns. If you just want to do an average job, you don’t really need a trained investment professional to pick your assets — just invest in an index fund. And if you want to beat the market, a mutual fund probably isn’t your best bet. While there is evidence that active managers do beat the market before fees are deducted, after fees they tend to underperform. That’s unsurprising, since mutual funds tend to be big, and beating the market gets much harder as the amount of assets under management increases.

Fund size, the authors found, is related to pay, but the relationship is again weaker than one might think — on average, only about 15 per cent of the fee revenue a fund gets from managing more assets gets passed through to the manager. And the relationship is even weaker for larger funds. Most of those enormous management fees are captured by mutual-fund companies, not by the people managing the funds.

So what do managers get paid for? Another recent paper, by Galit Ben Naim and Stanislav Sokolinski, offers one possible answer. Ben Naim and Sokolinski looked at Israeli mutual funds, using extremely comprehensive data collected by the Israeli government. Like Ibert et al., they found that market-beating performance was only weakly related to compensation — a one-standard-deviation increase in the amount that a manager beats his or her benchmark meant only a 5 per cent boost in pay, slightly better than what Ibert et al. found, but still pretty small.

Ben Naim and Sokolinski found a larger effect of fund size on manager pay — about 30 per cent, or roughly twice the size of what Ibert et al. found. Furthermore, they found that managers captured 40 per cent of the fee revenue that comes from investors putting more money in the fund (rather than increases in size that come from market returns, or from the company handing the manager more assets to manage).

These findings suggest that mutual-fund managers are paid less for beating the market than for marketing — i.e., the ability to collect assets. High passive returns, even if they aren’t due to skill, attract new investor money, which gets the company more management fees. And when more investor money comes in, managers get rewarded.

[JAYSLOL]

Yep, there's less money to be made getting your clients a good return vs. selling them crap. 

[Missy B]

I think it's true about the marketing. They don't earn their money in my opinion. They don't know what's going to happen any more than anyone else who follows financial news. They are good hand-holders at best.
The rare ones who are way up there in skill set and can see what the markets are telegraphing early with any accuracy are not doing retail-level financial planning. And they are ridiculously overpaid too.

People feel confused and afraid of the markets and managing their own money. They find someone who appears knowledgeable and confident, and who can calm their client's anxieties. And then they add several years to their clients retirement by scrapping so much off each year, and by putting them in mutual funds that don't even match the index.

[alanB]

I was going to add that money managers do one positive thing, help people to invest if they would never do so otherwise.  But then I found out that the article is cropped off in the OP at that point:

This bolsters the notion of “money doctors” — the idea that managers mainly add value by building trust with investors. Investors are naturally wary about putting their money in stocks and other risky assets, and want a qualified professional to tell them it’s safe to do so. This could potentially be a win-win relationship; investors pay fees, but get higher returns than they would if they had stayed out of the market. Or it could be a potentially toxic relationship, if managers use personal or cultural affinity to sell investors on a bad deal. More research is needed in order to tell how many money doctors are really quacks.

Interesting comparison to doctors.  I also get frustrated when I have to pay to confirm a diagnosis that I easily could make myself.  You could also argue that nutritionists are just as bad... paying to hear "lose weight, eat better" makes as much sense as "stick to low-cost index funds,"   yet that is still better advice than what you get sometimes.  Then again I think that most people are overpaid, including myself ;)