As regular readers of this blog will know, there’s a wide disparity between image and reality in the asset management industry.
For example, the City of London is seen as a world-leading centre of innovation and competition; the reality is that the myriad products consumers have to choose from are remarkably similar to each other, and fees have remained stubbornly high.
The image that many people, even now have of active fund managers, is that they are expert stockpickers who make their clients wealthy; the reality is that almost all of them fail to beat the market on a cost- and risk-adjusted basis over the course of their careers.
The question is, why does this system continue to exist? After all, virtually every other sector of the economy has become increasingly efficient over the last 40 years or so. Why does asset management remain so stuck in its ways?
The Role of Sociology
A new book provides an intriguing answer. It’s called Inertia: Sticky Relationships and Ossified Ideas in Financial Markets, and it was written by Yuval Millo from the University of Warwick, Crawford Spence from King’s College London and James Valentine, a consultant and former academic in the US. (1)
What’s so interesting about Inertia is that it focuses not on organisational or behavioural factors, as previous research has done, but on sociological ones. Rather than viewing financial markets as static or purely rational, the book underscores their social construction.
The authors describe a world shaped by entrenched interests and by “slowly evolving communities whose habits (and) routines… (These) can be difficult to shift, even when faced with overwhelming evidence that what they are doing doesn’t work most of the time."
“Purposeful inertia”
The central argument is that the fund industry is marked by what Yuval, Spence and Valentine call “purposeful inertia”. The book explores two interlinked forms of inertia: social and epistemic. Social inertia refers to the persistent, sticky relationships and norms within financial markets that resist change, while epistemic inertia reflects the entrenched attachment to traditional ways of thinking. These inertial forces create a feedback loop, reinforcing each other and sustaining the status quo.
A striking example, the authors point out, is the resilience of active fund management, “even though the economic analysis appears to suggest that better outcomes are offered elsewhere."
Although index funds have grown significantly in market share, active managers continue to thrive in absolute terms. This persistence is not simply due to habit or complacency, the book suggests, but is often a deliberate effort by incumbents to maintain their dominant field positions and preserve long-standing relationships.
The result, say the authors, is an environment in which groupthink thrives and challenging accepted norms is discouraged. "Disrupting existing relationships,” they write, “would lead to internal friction within firms... so a decision is made not to rock the boat or push for change.”
What Active Managers Really Think About Passive
Interestingly, Yuval, Spence and Valentine found that fund managers spoke much more candidly about the rise of passive investing in private than they do in public. As part of their research for the book, they conducted interviews with 70 investment professionals in Britain and America, mainly active managers.
What struck them was the information the professionals volunteered, without even being asked. Most of them saw the rise of passive investing as an existential threat to active management. Many conceded that investors are better off using index funds than active funds, and others even said they wouldn’t invest their own money in the funds they were managing.
Ray, a sell-side analyst in New York, admitted during his interview: “All my own money is in index funds.” When the interviewer suggested to him that this was a contradiction, Ray replied: “It is, right? Isn’t it interesting? … I will come across as cynical. It’s a good thing it is confidential and off the record.”
Will active management survive?
Despite the anxieties they encountered within the fund industry about the future of active management, the authors are far from convinced that it’s in terminal decline.
In the conclusion, they write: “It is tempting to view the active fund management community as a population on the verge of collapse, its members diminishing in numbers as the ecosystem surrounding them becomes less and less bountiful.
“However… history is full of bad or outdated ideas that manage to persist despite their shortcomings having been well recognized — from the QWERTY keyboard, to fossil-fuel addiction, to religious cults and beyond. Active fund management… may well persist due to the purposeful action of its member groups.”
True, outflows from active funds reached new records in 2024, and profits continue to be hit hard. But don’t write off the chances of active management surviving, and perhaps even a modest revival. As the authors rightly say, it “remains remarkably successful in carving out a role for itself and convincing investors to place their faith in it.”
This article is produced by us for Financial Advisers who may choose to share it with their clients. Timeline Planning and Timeline Portfolios do not offer direct-to-consumer products.
ROBIN POWELL is a freelance journalist and editor of The Evidence-Based Investor. He interviewed one of the book’s authors, Crawford Spence, for Episode 9 of The Investing Show, which you can watch here.
References:
- Inertia: Sticky Relationships and Ossified Ideas in Financial Markets, by Yuval Millo, Crawford Spence and James Valentine, is due to be published by Columbia University Press on 4th February 2025. https://cup.columbia.edu/book/inertia/9780231559270
