What’s the Future of Active Management?

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Hal Weitzman: It’s a relatively tough time for investment managers: investors are demanding ever lower fees and better performance, both of which are squeezing money-management firms’ profits; technology is transforming the industry; and the prospect of tighter regulation is always a concern. So how are investment management firms navigating these challenges, and who will be the winners and losers from the changes ahead?

Welcome to The Big Question, the monthly video series from Chicago Booth Review. I’m Hal Weitzman, and with me to discuss the issue is an expert panel.

Lubos Pastor is the Charles P. McQuaid Professor of Finance at Chicago Booth. Ram Parameswaran is a partner and portfolio manager at Altimeter Capital in Menlo Park, California. Andrew Plevin is co-CEO of BroadRiver Asset Management in New York.

Panel, welcome to The Big Question. For our two guests, who are both Booth MBAs, welcome back to Chicago Booth.

Ram Parameswaran: Thank you very much.

Hal Weitzman: Ram Parameswaran, let me start with you. We talk about this pressure, downward pressure on fees. How is that affecting the industry? How has it already affected the industry?

Ram Parameswaran: Right. So people talk about pressure on management fees, and it’s real. One of the main reasons there’s pressure is because of the big shift to passive-management techniques. But generally what I’ve seen is, if you can provide a strategy and a product that provides outstanding returns and investors believe that that strategy is sustainable over time, you will not see those pressures in management fees.

Hal Weitzman: So does that mean the poorer-performing firms are the ones who are feeling it most, who are coming under more—?

Ram Parameswaran: We don’t have any specific evidence of that because these things change over time. But if you continue to perform poorly over time, your investors will ask questions, and then it’s a negotiating strategy, and everything else.

At the end, asset management firms are businesses. There’s overall pressure because the hedge fund industry has been a relatively poor performer over the last few years right now. Index strategies and passive strategies have done better than many hedge funds have. But if you have strategies that actually work quite well, in sectors that people want to be exposed to, then there is a relative less lack of pressure. So it’s ultimately the product you provide to the industry, and the value you show over a period of time.

Hal Weitzman: Andrew Plevins, do you agree?

Andrew Plevins: Well, I agree with what Ram’s saying in general. I think that, for BroadRiver, we compete and manage assets in alternative investments, so it’s not with respect to index funds or mutual funds. But there is certainly pressure from the institutional market to contain fees, to lower fees.

I agree with Ram that it is important to be able to provide a differentiated value proposition: a type of asset or industry that you have expertise in, and that helps to protect you against some of that downward pressure. But it is present, and it’s coming from pension plans, endowments, and the consulting firms who advise them.

Hal Weitzman: Is it the case that more and more investment management firms have moved toward those kinds of assets in order to justify fees, or those that were already there are able to collect the fees and the others are finding it very, very hard?

Andrew Plevins: I don’t know that firms have sort of moved there to justify the fees, but clearly there’s been a tremendous growth in firms focused on alternative investments.

The private-equity universe, for example, has grown dramatically, and the number of managers and the assets under management have really exploded. Clearly they have higher fees in there than, say, index funds. But investors are finding the risk/reward worth it, otherwise they wouldn’t continue to allocate capital.

Hal Weitzman: Lubos Pastor, let me bring you in. You have more of a, give us more of a historical view about what’s happened to fees and what we might expect.

Lubos Pastor: Fees have come down, as we’ve already heard.

Hal Weitzman: Just tell us what’s been driving that.

Lubos Pastor: I believe it has a lot to do with assets under management going up. If you think about the fee revenue, the total fee revenue of an asset management firm, it’s basically AUM [assets under management] times the fee rate, and we’ve seen AUM going up, in part because asset values have been going up, stock prices, bond prices going through the roof, new money coming in. It’s perfectly reasonable for the fee rates to go down somewhat. Even if your fee rate goes down by a quarter, if your assets under management double, your fee revenue is higher than it was before.

So even though people talk about fees going down and profits being squeezed, things are not as bad as they seem. This is still one of the most lucrative sectors out there. If you look at profit margins in asset management, they’re very different from profit margins in consumer goods.

Hal Weitzman: Give us a sense of what you think, how you think this trend is gonna continue.

Lubos Pastor: I think there’s a real—

Hal Weitzman: You say that assets under management have been growing partly because asset price has been going up. So if we have a correction to that, which many people expect, does that mean there’ll be even more pressure on fees?

Lubos Pastor: Short-term corrections are not gonna do much here. We’re talking about long-term trends. I do think there’s room for fees to go down a bit more and, yeah, if asset prices continue rising, it makes sense for fees to remain stable or keep going down.

Hal Weitzman: More and more funds have been flowing into passive funds for many, many years. How have active versus passive funds responded to this changing fee environment, Ram?

Ram Parameswaran: It’s tough to say. Passive funds are passive funds. They can work on very low fees. I think active managers, at the end of it, we have a research process. We want to make sure we do the best research process in the world to come up with insights that we can put trades into. In general, as long as your LPs are OK with your strategy, they are supportive of paying fees to support that long-term strategy.

From our perspective, I just think it’s . . . We run it . . . it’s a lot like a business. I don’t think people respond to changes in fees. Because the worst thing you want to do in the active-management business is to change your process. Because if you’ve got a process that works over many decades, you want to keep going on that process. The fees eventually take care of itself.

There are ways to offset fees. You can do more offshoring. You can do more automation. You often look at every research provider who comes to you. You can cut down on travel. There are ways to offset fees in this business as long as your process—

Hal Weitzman: Just don’t go too far cutting down on travel. Steady on there, Ram.

Ram Parameswaran: You’ve seen people who are, where . . . a lot of the stuff, because of technology, can be, you don’t have to have natural feet on the ground all the time. There’s a lot of video-conferencing solutions available. There are ways of doing things remotely, which have affected all kinds of businesses around the world. Asset management and active management is no different. I think it’s incumbent upon active managers to think about smart ways to save money for their investors. Right? That’s the way every business should react.

Hal Weitzman: Lubos, do you have a view on active versus passive?

Lubos Pastor: Yes, just complementing what Ram has already mentioned, a useful anecdote was the example of AllianceBernstein, a large, $500 billion asset management firm who, earlier this year, announced that they’re moving from New York to Nashville. This is an active firm that has found a way of cutting costs. The cost of living in Nashville is about half of what it is in New York. That’s one of the creative ways of cutting down on costs.

Among passive managers, somehow they’re finding ways of cutting those fees lower and lower. Just last month, in August, Fidelity actually launched two zero-cost index funds, the fee all the way to zero. I assume they make money off of securities lending, and maybe it’s a loss leader to get people in the door, but it’s a very exciting development. I’m curious whether we’ll see negative fees down the road.

Ram Parameswaran: To add to Professor Pastor’s point, some of the best investors in the world don’t live in New York. They live in Omaha. The beauty about the active-management business is, outside of management meetings, everything is intellectual. You can do it in any part of the world. People can complain about fees all they want, but you can be smart about it. You can still retain your core investment process, which is the heart and soul of active management, and find smart ways around this.

Hal Weitzman: You also talked about offshoring. Is that something that we’re seeing a lot of?

Ram Parameswaran: Offshoring in a sense that a lot of the back-office functions could be made offshore. Just the way you had the rise of the BPO industry and the rise of offshoring for technology firms and businesses all over the country through the 1990s and 2000s, there are a lot of back-office financial-services firms that everybody uses, both the buy side and the sell side, in many countries in the world.

Hal Weitzman: How do you see this trend toward passive management continuing? Will it continue? Are we at the apex? Ram, what’s your view on that?

Ram Parameswaran: It’s a difficult question to answer. I don’t think passive management is going away anytime soon. I think that’ll keep going. That’s an ongoing trend, especially if you’re a retail investor.

Hal Weitzman: But will it keep growing, I guess is the question.

Ram Parameswaran: I think my best guess today is it’ll keep growing. Does that mean that active management is dead? Absolutely not. As active managers, we have to find niches and strategies and value-additive solutions for our clients. The world evolves, and we have to evolve with it.

Hal Weitzman: Andrew Plevin, what’s your view on the future of passive management, whether we continue to see more funds flowing into passive strategies?

Andrew Plevin: Clearly, the flow of funds into passive has been the dominant flow into the indexes and ETFs. I think that trend will continue because of the cost advantage. It’s an easy decision for an individual investor, a retail investor, to make. They don’t have to really assess performance. They’re buying an index, a capitalization-rated index, of a market. That’s a simple decision. And probably for most retail-type investors, a good decision, and certainly a low-cost decision.

I think people like Jack Bogel, who helped create the whole idea of an index, are really heroes to retail investors. I do think, at some point, the trend does go too far, and it really does create the opportunity for active managers because, by its nature, index funds and ETFs don’t create price discovery. They’re simply moving capital toward an index or a set basket. There is not a form of price discovery that’s happening. Active managers should be able to thrive against that.

Ram Parameswaran: Correct.

Andrew Plevin: And I think that’s really the longer-term opportunity for active managers: finding strategies where you can benefit, and it’s not simply following a capitalization index.

Hal Weitzman: Lubos Pastor, how long will we see this trend toward passive management continue?

Lubos Pastor: I think we’re gonna see it continue until the performance of active management improves to the point where investors are going to be happy investing actively. Essentially, what we’ve seen in the past few decades is that the active-management industry has been too large, in the sense of being too competitive. Essentially, the degree of competition has been too big, as a result of which, the majority of active managers have not succeeded in beating their benchmarks.

Now, as money shifts from active to passive, essentially what that means is that there’s less and less competition among active managers and as we’ve already heard, it’s gonna become easier . . . it is becoming easier for active managers to outperform. I think the moment investors become indifferent between active and passive, that’s when the trend will stop.

Hal Weitzman: You’ve actually conducted some research on this whole question of active managers and performance and whether they’re really bringing more skill. Just remind us briefly about—

Lubos Pastor: This is exactly what we’ve written about with my coauthor Rob Stambaugh at Wharton. Essentially, we try to estimate: What is the right size of the active-management industry? Where is that equilibrium point at which investors are gonna be indifferent between, between the two?

Hal Weitzman: Tell us: What was your finding?

Lubos Pastor: It’s hard to pin it down. We understand better why it’s difficult to find the equilibrium size of the industry.

Hal Weitzman: We’ll have to read the paper. Yes, Andrew Plevin?

Andrew Plevin: I think the index and passive strategy, which has clearly seen the benefit of tremendous inflows, is not without risks because, in many of these, by just following a standard ETF basket or the capitalization-weighted index, they’re essentially following momentum. It becomes very self-fulfilling. But at some point, that momentum can be broken, or will be broken, and the concentration of many of the indexes, or especially the ETFs, is much higher than commonly perceived.

For example, if people think of investing—I’ll just take an example because I looked at this a few years ago—you want to invest in an emerging market or a developed market like Spain. There are ETFs and iShare, for example for Spain. It turns out that about 50–60 percent of that index is invested in maybe 10 stocks. Most of those stocks actually aren’t representative of the Spanish economy, but they are Spanish companies with principal exposure to Europe or to the United States. So you’re not really getting the benefits of diversification that you think you’re getting. I do think there are risks that are being embedded—

Hal Weitzman: Wouldn’t that just drive better ETFs?

Andrew Plevin: It may. It’s very interesting. It may. We’ll have to see if that happens. ETFs tend to focus on liquid names because they need to be tradable. So it tends to become very self-fulfilling about what stocks ETFs select.

Hal Weitzman: Lubos, you were a little bit dismissive of my question earlier about a correction, but I wonder if so many people have seen index funds going up—we’re in the longest bull market, by some calculations, that we’ve ever had in the United States—if there’s a sharp correction, will that make even the standard retail investor rethink their commitment to having the lowest fees possible and just track the performance? What do you think, Ram?

Ram Parameswaran: It’s hard to say. It really is hard to say. We’re trying to figure out what the average retailer investor would do. Listen. I think, first of all, the rise of passive management absolutely creates more opportunities for active managers. If there is a correction—

Hal Weitzman: Just explain what you mean. Explain that comment. By “create more opportunities,” you mean: to show their skills?

Ram Parameswaran: To show their skills because, again, if everybody’s going in one direction and then the machines and the quants are kicking in, literally just following the trend, without thinking through the true consequences . . . you can take the extreme version of this.

The extreme version of quantitative investing or ETFs is machines run everything. It’s a machine-learning system that trades the market. I thought about this question a few years ago, saying, hey, will I have a job in 25 years if this were to happen? Will A.I. and machine learning take over the world of investing? Then Andrew Ng, a famous professor at Stanford, who now runs deeplearning.ai, is like, “Well, it turns out that the stock market’s one thing that’s a random walk.”

So you can actually not train a machine to react to solutions because every time. It’s a different . . . it’s a collection of millions of participants in the market. It turns out that, as things get more passive in the long term, I think if you have the right strategies, you should be able to outperform as an active manager. Then, back to Professor Pastor’s point, everything rebalances itself in terms of fees, and interest, and retail investors.

I know that’s not the question you asked but, I kind of spun off . . .

Hal Weitzman: No, but actually you just segued beautifully onto my next topic, which was gonna be technology. You talked, maybe a little bit dismissively again, about automation and passive management and robomanagement. How is technology changing active management? Andrew Plevin?

Andrew Plevin: I’d say our firm is still . . . let’s call it old school. We mainly use investment analysts and our own models. We’re not using heavy amounts of machine learning or large data sets. We, ourselves, are adapting. We are incorporating more and more large data sets in what we do. It is helpful. I think the trends are probably inevitable in that way because the cost of processing is so infinitesimally small now, the ability to manage and process huge data sets is so available through the cloud. I think it’s leading to better informed decision-making.

Hal Weitzman: Ram, what has been your experience?

Ram Parameswaran: I agree. There are two parts where technology’s affecting investments in general. One is just the trading aspect of it, and that’s been the case for 25 years now. You went from passive management, to machines doing trading, to now machines fully controlling the trading strategies. That’s the trading side of the business.

That’s why I sense, again Professor Pastor probably has more data, you see more volatility on new information today in the market than you ever did probably 20 years ago, and that’s just a hunch I have. In terms of active—

Hal Weitzman: So you’re ascribing the volatility to autotrading?

Ram Parameswaran: To basically a lot of autotrading, because machines are going to keep driving the price up to the point of resistance and, if there’s no resistance, they will overshoot because they don’t know better, unless there are controls in place—and these are humans writing those algorithms, so we don’t know quite how they actually work. Again, we are also pretty old school in the sense that we have . . . I’m an analyst. I look at companies on a fundamental basis, and so do everybody on the team.

From our perspective, data and imbibing data sets and thinking through what gives us edge in the investment process, it’s an efficiency situation for us. Let’s say, back in the day, we’d have to hire two or three analysts to crank or crunch through a data set and then put something in a nice table and have the insights for a portfolio manager. Now a lot of that stuff can be automated away.

From our perspective, technology is an automation tool just like any other business. It helps create efficiencies and reduce costs in the business.

Hal Weitzman: OK, which takes us back to the conversation we were having at the beginning. Lubos Pastor, you’ve also done research on volatility, have you not? In stock returns.

Lubor Pastor: Yeah . . .

(crosstalk and laughing) We do all kinds of research.

Hal Weitzman: What’s your view on Ram’s point about volatility being caused by more autotrading?

Lubos Pastor: There could be some of that. There’s also an offsetting effect, which is that it’s through technology that we have superior liquidity provision nowadays. You have all these high-frequency traders that are the modern market makers. They’re able to cushion some of the moves back and forth. There’s a lot of debate about whether ETFs might be causing more volatility, but then other aspects of technology might be reducing it. Certainly, in the past couple of years, there hasn’t been all that much volatility.

On technology, I think it’s creating new profit opportunities for active managers. Now, instead of just using analysts poring through company books, you can have computers poring through texts of earnings announcements. You can have computers analyzing satellite images to see where demand is, where demand is weaker. There’s a lot of opportunities for active.

On the passive side, or semipassive side, we’ve seen a tremendous rise in so-called smart beta products. Which is, again, a sort of a technological advance in that people automate—

Hal Weitzman: Just explain briefly what that is, yeah.

Lubos Pastor: People automate, in a quantitative sense, they automate the active-investment process. Instead of people doing calculations and trying to figure out the right portfolio, you have a computer just doing a screen, a simple screen, and then constructing a portfolio that tracks some kind of an alternative index. But it’s very quantitative. It’s very cheap.

Hal Weitzman: Are you using any of those techniques that Lubos, or have you seen in the industry, those techniques that Lubos talked about, like text analysis and going through conference calls and looking for signals, which, by the way, in Chicago Booth Review, we have covered some of this research about the signals that are contained in the language of conference calls. Are you guys looking at that kind of technology? Do you adopt it?

Ram Parameswaran: I would say we do it in great depth. We are very focused on trying to get sources of edge, so we do a lot of the stuff that Professor Pastor talked about.

Andrew Plevin: The one area that, just in terms of discussion, I would take a little bit of a different view on is we’ve mainly been talking about equity markets, and I think the idea of technology and algorithmic trading and that really replacing what used to be market makers has really not had such an impact, more on the fixed-income markets.

We focus more on alternative fixed income. What we really have seen is that the role that used to be played by the investment banks or large broker dealers in the fixed-income markets has really pulled back. There hasn’t been a step in for market making by liquidity providers using algorithmic trading. So for these markets, the volatility is not high.

I think that has to do with the general macro environment. It’s built on a lot of fragility in terms of the underlying liquidity behind it. And so if you do need or want to move a large fixed-income position, there isn’t a lot of depth in those markets now. It will be interesting to see what happens when the markets turn more challenging.

Hal Weitzman: Another beautiful segue, Andrew, into what I want to talk about next, which is alternative investments, which you said you’re heavily involved in. How do you think about the traditional versus the alternative?

Andrew Plevin: I’ve really built my career at BroadRiver focused on alternatives. I think it’s, in part, a reflection of the fact that I think it’s quite hard, at least from my background, to create a competitive advantage in the general equity markets. Where I have built expertise was really more in the alternative fixed income. We happen to focus on a lot of niches, which are relatively inefficient and do not trade frequently. BroadRiver, where I think there is opportunity . . . I think private-equity firms and also alternative fixed income, like private credit funds, they’re trying to find where illiquidity can bring higher return. So the trade-off is: sacrifice liquidity, trade that for some illiquidity, and hopefully an additional return. I think that’s where a lot of the pension plans, endowments, and other institutional investors have allocated capital.

So that is what BroadRiver focuses on. I think those niches are, inherently, a little more defensible because it’s hard for an index fund to be created around some of these assets. It’s hard for a BlackRock to move tens of billions of dollars into these assets. So they’re inherently smaller and more specialized, and expertise does matter.

Hal Weitzman: Ram Parameswaran, does that mean we’ll see more-sophisticated investors moving into these kinds of products and assets?

Ram Parameswaran: We’re already seeing it. I invest in technology companies around the world, and we’ve been looking at public and private assets for a few years now. This is our equivalent of automative investments. I think that is generally true. It is hard because public-market investors, equity-market investors, are historically . . . It’s a special skill set to do private equity and growth capital investing, I think. I think it’s a skill that can be built over time, but we’re already seeing that trend. Many of the biggest firms in the world that I respect are looking at this very actively as a source of creating wealth, and I see this across both mutual funds and hedge funds.

Hal Weitzman: Lubos Pastor, do you have a view on that?

Lubos Pastor: Yeah, I completely agree with Andrew’s earlier point, that if you go to private equity or other alternatives, you’re basically—the trade-off is you’re sacrificing liquidity, but on the other hand, you have more opportunities to create value. If you think about where you’re more likely to find mispriced assets, you’re more likely to find such assets in an illiquid market where there’s less competition.

Of course, the flip side is that you better be really good if you operate in those markets, because there’s also more room to get burned. I think the superstar athletes here can do very well in alternative investments.

Ram Parameswaran: Isn’t there the alternate point in that part of crowding, though? Because you normally think that a private-equity investment is illiquid, less well-known, but actually in technology, there’s just a lot of capital.

So funny enough, we’re at a point, right now, at least recently, where the public markets are, in some ways, quite inexpensive and the private markets are extremely crowded. There’s just a lot of capital being allocated to technology firms that are private. So valuations are definitely a little stretched, and I say that very mildly. You can see better investments in the public market.

I think in general that point is true, but I think, like everything else, when money crowds into one sector or subsector, it gets expensive.

Hal Weitzman: I wanted to talk about performance, because you were saying earlier that the firms that can perform are the ones that will survive, or the ones where people will be prepared to pay the higher fees. There’s some evidence that larger funds have trouble competing. Have you seen that in the market? Generally, what are the challenges facing funds on performance?

Andrew Plevin: I’ve actually seen an opposite trend, Hal. That is that larger firms are actually attracting more capital. They are able to do that—

Hal Weitzman: We’re talking about funds rather than firms but, you’re right, there’s been a lot of consolidation, absolutely.

Andrew Plevin: But, speaking about the private-equity and the alternative universe, name-brand firms such as a Carlyle, Apollo, and KKR, they have been able to raise larger and larger funds and also extensions of funds. So it’s become a rush of money to the name-brand funds because it’s seen as a limited availability of opportunity, and some of the larger firms have been able to deliver excellent returns. Pensions, endowments, and the like really want to allocate them.

It’s much harder for small firms, or new firms, to break into those industries. And in fact, the growth of alternative-investment firms like private-equity-type firms, has probably more than doubled over the past 10 years. I don’t know the exact numbers, but I do remember back reading something around in 2000, there were about 200 private-equity firms. There’s more than 2,000 in existence in the United States today. The lion’s share goes to the large names.

There’s a lot of reasons for that. I think scarcity of opportunity is one, from the allocator standpoint. There’s certainly safety in going to a large name. Three, I think, we think about LPs; they’re busy. So, time and attention. Do we want to have a lot of small managers, which are hard to monitor? Portfolio monitoring becomes much more difficult than if you give a larger allocation to a larger firm, where you already have capital under management—

Hal Weitzman: Tell us what LPs are.

Andrew Plevin: Limited partners are the allocators of capital into private equity.

Hal Weitzman: So that would include?

Andrew Plevin: That would typically include pension plans, endowments, or other large institutional investors who allocate capital into illiquid structures, usually private-equity-type structures. LPs are busy and they don’t want to have too many managers to monitor. So they tend to concentrate—

Hal Weitzman: Gravitate to the big firms, yeah. And of course, in investment management, we’ve seen huge consolidation with BlackRock, and State Street and Vanguard taking all the business. So presumably, that may be a trend, it sounds like, that will continue in the years ahead.

To go back to this question of performance, Lubos Pastor, about the large funds versus new smaller funds, what does the evidence tell us?

Lubos Pastor: There’s fair amount of academic research on mutual funds, where we have better data than on private equity,and there the conclusion seems to be that larger funds do perform worse. The evidence is not terribly strong. They certainly don’t perform better. People tend to ascribe it to liquidity constraints. Basically, the larger you are, the harder it is to outperform. For one thing, you have to change your behavior. When a fund becomes larger, it can no longer play in the same small-cap universe. Now it has to shift into larger-cap stocks.

Hal Weitzman: Everything is very obvious, and it’s got a big, heavy footprint everywhere it moves.

Lubos Pastor: That’s right, exactly. It moves prices. Price impact is larger. A larger fund has to trade less than a smaller fund. You see these trade-offs taking place.

Hal Weitzman: Let’s turn, finally, to talk about regulation, which I know you’re all desperate to talk about. Is there a concern about regulation in the industry? Should the biggest firms be regulated more? Are they systemically important, Ram?

Ram Parameswaran: Tough to say. I mean, listen, I think regulation is important. I believe in it, believe it or not. I think it mitigates bad behaviors. At the end for active managers, we all have one rule. It’s called the Wall Street Journal rule. Don’t do anything that will get you on the first page of the Wall Street Journal. I think that’s a rule we all live by. Keep your nose clean. Life’s too short to do stuff that is illegal.

Regulation, I think, is going to be a part of the business. It’s something that you just have to accept and believe if you can abide by that. If you can’t abide by that, then you gotta do something else.

Hal Weitzman: Andrew Plevin, do you have a view on these, kind of, big giant firms that we talked about? Are they systemically important? Should they be regulated more?

Andrew Plevin: I don’t have a deep academic view, but having gone through the financial crisis—and I’ve been in the market since 1986, when I started working out of college—there are certain firms that really do matter to the liquidity of the economy and to the financial system. We’ve seen that with banking firms; they necessarily attract a lot of regulation. I do think money-market funds became a tipping point in the financial crisis in ’08 because liquidity stopped and they broke the, sort of, one-dollar trading value, and so I think that’s an area of sensitivity. It probably did attract more regulatory scrutiny and probably still needs that type of scrutiny because it is such a substitute for cash and liquidity in the economy.

Hal Weitzman: Lubos Pastor, should we expect more regulation of these investment-management firms?

Lubos Pastor: I think regulation matters and is important in situations where markets fail. We need to regulate banks, for example, because market failures can occur in the banking sector. We can have bank runs, which can, basically, liquidate a perfectly healthy bank. Mutual funds and investment firms, more generally, I think we need some regulation, but we certainly . . . I wouldn’t regulate them nearly as heavily as banks. You can get runs on mutual funds because they tend to hold less liquid assets than the liquidity they provide to their investors. But the effects of runs on funds are different from the effects of bank runs and they’re not as bad for the economy.

What I would do as a regulator, perhaps, is pay closer attention to the liquidity mismatch in investment firms—like, how much liquidity are you offering to your investors versus what’s the liquidity of your assets?—in order to mitigate the fire sales that would be induced by massive withdrawals. Besides that, I wouldn’t go much further.

Hal Weitzman: I’m sure that will be music to many people’s ears.

(group laughter)

On that note, our time is up. My thanks to our panel, Lubos Pastor, Ram Parameswaran, and Andrew Plevin.

For more research, analysis, and commentary, visit us online at review.chicagobooth.edu. Join us again next time for another The Big Question. Goodbye.

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