Monopsony Monday: Or, How I Learned to Stop Worrying and Love Market Power
I read a great article in Dealbook today on the growing dissatisfaction of large investment funds with the asset managers they pay hand over fist to manage their money. And they should be dissatisfied; a slew of recent articles point out the poor job that hedge funds, private equity funds*, and VC funds have done managing money. And these asset managers have done a very poor job of it as well, demanding exorbitant fees in exchange for returns that generally fall short of the public markets. Their redeeming virtues are twofold: one, they provide some diversification, and two, it’s not really practical for a pension fund with $250B in cash to just plunk it into index funds. So the pension funds (and sovereign wealth funds, etc) actually do need the alternative investment opportunities.
But the asset managers need the large funds more. The huge pools of assets that asset managers work from are provided primarily by large investment funds. There are also wealthy individuals and occasionally some other funders, but the big customers in the asset management business come from the pension funds and sovereign wealth funds of the world. Hence you have oddities like the Ontario Teacher’s Pension Plan profiting by ripping apart American unions, through the intermediaries of rapacious private equity firms. Ultimately, these large institutional investors are the lifeblood of the alternative asset management business. As Dealbook reports, they have begun focusing on ways to sideline the asset managers. While it might be presumptuous to suggest anything to these seasoned pros, that’s not the only thing they should be considering.
An innovation from the medical field suggests that these funds shouldn’t be aiming to sideline managers, but to exert market power. Group purchasing organizations are when medical providers (e.g., hospitals) team up to purchase supplies in bulk from vendors. By pooling their purchases to form a larger account, they can negotiate down the price. The ultimate extension of this is a monopsony, or a single buyer for a product – monopsony power is how single-payer health systems keep down costs. Large investors, and especially cash-strapped public pension funds, should be seriously considering forming group investing organizations. By exerting their huge potential market power, they can bargain down the price of alternative asset management. This is likely to be a lot more practical than attempting to run their own asset management operations on public-sector salaries.
This might be some time off, but that same logic points out the clear next step: pension fund consolidation. New York, for example, pays roughly $400M to Wall Street a year in management fees. It also, not coincidentally, has five pension funds instead of one. Merging them could create huge savings. In 2011, Comptroller John Liu tried to do just that, which it was estimated would save the city a billion dollars a year…but it ran aground on his personal financial scandals. With an active race for comptroller today, the issue absolutely needs to come back. Failing to leverage market power for pension funds is an unconscionable waste, and basically amounts to setting giant piles of money on fire.
It’d be the easiest billion dollars ever made.
*: PE does better than the other asset classes! It actually seems to earn alpha net of fees…but that comes with a slew of caveats. The investments are highly illiquid and long-term like VC, and measuring returns encounters the survivorship bias issues that haunts assessment of hedge fund returns. So it does seem to earn a genuine return above public markets, but with many big disadvantages.