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Fund business produces billionaires by the dozen

The money-management business makes a great road to riches.

Anyone harboring the slightest doubts about that statement can dispel them with a look at the latest Forbes magazine tally of the 400 wealthiest Americans.

In one quick glance down the list, I picked out 25 people whose fortunes derive from the decades-old boom in investment management. They range from two members of the Johnson family that built Fidelity Investments in Boston, the biggest mutual-fund manager, to Joseph Mansueto, whose Morningstar Inc. in Chicago specializes in research on funds and other investments.

A dozen boast fortunes that Forbes specifically attributes to hedge funds, the partnerships for sophisticated investors that have been among the hottest of all financial products in the early years of the 21st century.

That total doesn't count chairman Warren Buffett and two of his associates at Berkshire Hathaway Inc. Buffett's insurance and investment conglomerate has often been characterized as the ultimate hedge fund, in effect if not in name.

Just days after the annual Forbes list came out, one money manager who made it found himself the subject of less-flattering attention. A New York Times story reported on a lawsuit crying foul over the amount of pay collected by Mario Gabelli, founder and chief executive of fund manager Gamco Investors Inc. in Rye, New York.

Mixed emotions

The suit, filed by a longtime investor in Gabelli's business, was hardly the first ever filed between stakeholders in an overflowing pot of money. This one helped to dramatize the love-hate relationship modern investors have developed with their hired guns in the markets.

As a source of riches, money-management has plenty of company in such other old standbys as real estate, oil and inheritance. What sets it apart from that group, now and forever, is the degree to which it involves the use of other people's money.

Money managers occupy a position of fiduciary trust, and any time that trust isn't honored the whole mechanism starts to fall apart. See the great mutual fund scandal that erupted two years ago this month, in which some of the worst offenses arose from managers trading for themselves in the clientele's fund shares.

Generic competition

We want our money managers to be sharks in the fierce environment of the markets -- but sharks on our behalf, not their own. This can lead to confused expectations, poorly calibrated incentives, and all sorts of other trouble.

Matthew Fink, retired president of the Investment Company Institute, recalls a conversation a few years ago with staff members who worked for a senator sponsoring a mutual-fund reform bill. When asked for his opinion of the measure, Fink said in a recent speech, "I concluded by stating that the bill would homogenize, commoditize and dumb down the mutual fund industry.

"I thought that I was extremely eloquent," Fink said. "But when I finished, the staffers said, great, that's exactly what we want to do."

These congressional staffers, one can readily infer, were fans of index funds, which dispense with the heaviest money- management exertions in favor of a generic, low-cost format. In more than 30 years since it first rose to popularity, indexing has not yet come close to killing off active money management. But it isn't through trying.

Going rate

Its greatest threat to active managers may just now be taking shape. More and more money-management clients nowadays are adopting the view that market-equaling performance doesn't merit any more compensation than what an index fund costs.

To earn the high pay to which so many of them have grown accustomed, money managers will have to get better results than the market -- something which simple logic tells us only a minority can achieve. Since index packages are readily available in many forms, including the growing menu of exchange-traded funds, it follows that prices anybody pays for market performance, known in the trade as beta, will naturally gravitate to index-fund levels.

None of this is theoretical, pie-in-the-sky stuff. These forces are already at work. They are exerting pressures that sooner or later could make money management a much less bounteous way to get rich.

Currier is a columnist for Bloomberg News.

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