Yesterday afternoon, the Wall Street Journal, New York Times, and other outlets reported that Black Rock, the world's largest investment fund management company with $5.1 trillion in assets under management, is radically revising its equity management offerings by announcing what the Times calls "an ambitious plan to consolidate a large number of actively managed mutual funds with peers that rely more on algorithms and models to pick stocks."
The move is being heralded as a sign of things to come in the world of asset management. Only a small percentage of assets managed at Black Rock were actively managed before the move -- about $201 billion at present, according to the Times story -- due to the firm's focus on so-called passive strategies, including ETFs (Black Rock owns iShares, acquired from Barclay's) and index funds. Now, the firm is reducing its emphasis on active management still further, firing several active portfolio managers and supporting staff, and instead emphasizing a lineup of "quant" funds, which rely more on computer models and algorithms. The news headlines are calling this move "Machines Rising over Managers to Pick Stocks" and "Relying more on robots rather than humans."
Reading further into the company's reasoning reveals that the firm's equity asset managers had underperformed index funds in recent years, that the shift to algorithms rather than managers allows lower management fees, and that leadership believes new technologies such as "big data or even artificial intelligence" are making human-based investing less relevant. The executive in charge of the change says, "The old way of people sitting in a room picking stocks, thinking they are smarter than the next guy -- that does not work anymore."
The Journal article does note, however, that Black Rock will retain some actively managed offerings, including "country- and sector-focused stock products in which executives believe they can outperform, funds that pursue specific outcomes such as social impacts, and riskier funds that make more concentrated bets" but that "The changes weed out actively managed stock funds that closely follow indexes."
As active managers ourselves, we approve of these changes at Black Rock, and do not see them as the "end of active management" due to the "superiority of the robots" (or the quants) at all. In fact, we believe that the largest mutual fund company in the world has just publicly acknowledged the drawbacks of huge funds that are forced by their size to "closely follow indexes" and has made a rational decision to focus on other strategies -- including those that make "more concentrated" investments (which is a strategy that we ourselves favor, and one we have used to outperform indexes over long periods of time).
In fact, we noted almost two years ago that the Black Rock CEO had inadvertently admitted what we believe to be one of the central problems of index and ETF investing -- the fact that they are forced to own everything, good and bad -- during an interview alongside Carl Icahn that turned into a fairly exciting debate. The same criticism can be applied to "actively managed stock funds that closely follow indexes."
That said, we personally do not favor quant strategies, for reasons we have detailed in previous posts (including one from 2010 discussing a story touting "AI that picks stocks better than the pros"). We believe that the single most important factor of successful investing involves having a consistent investment philosophy which informs your selection of companies whose stock you will own. This is the opposite of what algorithm-based strategies usually do -- because those algorithms are frequently changed to try to capture "what's working now." And, on a larger scale, Black Rock's shift towards more emphasis on quant strategies (in addition to their existing emphasis on ETFs and indexes) can also be seen as a shift towards "what's working now."
Of course, if their strategy is flawed, then they should change their strategy. However, we advise investors to be very careful when selecting these new strategies, if those strategies themselves are not grounded in a consistent investment discipline. Otherwise, in a few years, they might find themselves being told that now it's time to shift into the new "next best thing."
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