Investment management is in flux, arguably more than it has been in a long time. Active management is under pressure, with investors switching from active to index funds. New “smart beta” products offer low-cost exposures to many active ideas. Exchange-traded funds are proliferating. Markets and regulations have changed significantly over the past 10–20 years, and data and technology—which are increasingly important for investment management—are evolving even more rapidly.
In the midst of this change, what can we say about the future of investment management? What ideas will influence its evolution? What types of products will flourish over the next 5–10 years?
I use a long perspective to address these questions and analyze the modern intellectual history of investment management—the set of ideas that have influenced investment management up to now.
One central theme that emerges is that investment management is becoming increasingly systematic. Our understanding of risk has evolved from a general aversion to losing money to a precisely defined statistic we can measure and forecast. Our understanding of expected returns has evolved as the necessary data have become more available, as our understanding of fundamental value has developed, and as we have come to understand the connection between return and risk and the relevance of human behavior to both. Data and technology have advanced in parallel to facilitate implementing better approaches.
With an understanding of the ideas underlying investment management today, including several insights into active management, I discuss the many trends currently roiling the field. These trends, applied to the current state of investment management, suggest that investment management will evolve into three distinct branches—indexing, smart beta/factor investing, and pure alpha investing. Each branch will offer two styles of products: those that focus exclusively on returns and those that include goals beyond returns.
Contents
Foreword ix
Richard C. Grinold
Preface xi
Acknowledgements xiii
1. Introduction 1
2. The Early Roots of Investment Management 4
Pre-Modern History: The Early Roots of Investment Management 4
The Dutch Origins of Investment Management 7
The Evolution of Investment Management in Britain and the United States 9
The Evolution of Investment Data 10
Bibliography 11
3. The Modern History of Investment Management 12
The Origins of Systematic Investing 12
The Birth of Modern Portfolio Theory 15
Active Management Strikes Back 25
The Evolution of Investing 33
Appendix 33
Bibliography 34
4. Seven Insights into Active Management 38
Insight 1. Active Management Is a Zero-Sum Game 39
Insight 2. Information Ratios Determine Added Value 41
Insight 3. Allocate Risk Budget in Proportion to Information Ratios 45
Insight 4. Alphas Must Control for Skill, Volatility, and Expectations 46
Insight 5. The Fundamental Law of Active Management: Information Ratios Depend on Skill, Diversification, and Efficiency 50
Insight 6. Data Mining Is Easy 59
Insight 7. Constraints and Costs Have a Surprisingly Large Impact 65
Summary 70
Technical Appendix 70
Bibliography 72
5. Seven Trends in Investment Management 74
Trend 1. Active to Passive 74
Trend 2. Increased Competition 78
Trend 3. Changing Market Environments 81
Trend 4. Big Data 83
Trend 5. Smart Beta 86
Trend 6. Investing Beyond Returns 95
Trend 7. Fee Compression 100
Bibliography 104
6. The Future of Investment Management 107
Index Funds 107
Smart Beta/Factor Funds 109
Pure Alpha Funds 111
Investing Beyond Returns 112
Fees 114
Conclusion 114
Bibliography 115
