Surprise, surprise! The Banksters not always have your best interest at heart.
🧑💼The Managerial Power Hypothesis
Our thesis is that managing entities and third-party service providers alike hold enough power to pervert optimal contracting approaches, causing an agency problem that is inherent to the asset management industry. We label this as the managerial power hypothesis.
The growth in power of the intermediary sector – and the declining influence of the beneficial owners of capital – incentivises intermediaries to engage in rent extraction from the assets they manage, leading to rising costs of finance and sub-optimal beneficiary-intermediary relations.
🏦Inefficiencies in Asset Management
The traditional wealth management industry and the few currently existing DeFi asset management protocols are not built to adequately address the managerial power hypothesis. As a result, the asset management industry is burdened with inefficiencies. These include:
👎Opaque Accountability Frameworks
In TradFi, it is assumed that shareholders are ultimately responsible for their investments. If they are unhappy, they can sell their shares and exit the investment vehicle.
Naturally, not every shareholder who refuses to exit is voicing support for the adviser or its fees. Investors may believe that the trustees will protect them from exploitation.
👎Inflated Valuations of Fund Holdings
In TradFi, managing entities are tasked with the valuation of their fund's holdings, which essentially equates to calculating their own management fees.
Failure to adjust values of holdings downwards leads to the artificial increase of a fund's net asset value, which in turn leads to shareholders paying too much.
👎Higher-Than-Fair-Value Management Fees
This form of rent extraction is common in marketing and distribution fees, annual and quarterly custodian fees, and the loads and commissions paid to external consultants.
Under this arrangement, fund shareholders pay twice: through the original management and performance fees and in the form of increased transaction costs.
👎Excessively High Set-Up Costs and Barriers to Entry
In TradFi, the current set-up costs and requirement of a minimum of $50 million assets under management, automatically exclude smaller players from the market.
Moreover, alternative investment funds remain solely accessible to accredited investors with a net worth of over $1 million or an average income of $200,000 p.a.
👎A Disproportionately Long and Costly Intermediary Chain.
There is a structural dependence on service providers, transfer agents, the principal underwriter or distributor, brokers/dealers and the custodian.
All these intermediaries incur hidden costs, which lead to an increase in a fund's expense ratio. These costs are in turn absorbed by the shareholders.
👎Late-Trading, Market-Timing and Front-Running Arbitrage
Due to informational asymmetries, managers can buy fund shares at a discount or sell them at a premium before a specific event is reflected in the price.
This form of arbitrage is well documented essentially pits the adviser's financial interest against the interest of the fund shareholders.
👎Sub-Optimal Contracting Approaches
Trustees are compensated through regular paychecks for their services in relation to the assets under management of the fund, increasing the likelihood of collegiality.
The more assets, the greater the compensation. This preconditions trustees to seek and close advisory agreements that could very well be sub-optimal for the shareholder.
