Andrew Silton: Rising wealth of money managers has a downside

In an effort to come up with a column for this week, I started digging through two reports issued by the North Carolina State Treasurer about the performance of, and fees incurred by, North Carolina’s public pension plans. As is the case with most public pensions, the lion’s share of the fees is going to hedge fund and private equity managers. I couldn’t come up with a perspective that you haven’t read before, so I was struggling to put together this week’s column. Then I had lunch with a friend.

After describing to him in some detail the beneficiaries of the $490 million in fees paid out by the pension plan in fiscal 2013-’14, he suggested that the state’s money managers are probably well represented on the Forbes 400 list of richest Americans. He also told me that the composition of the Forbes list had changed dramatically over the years. As we ate lunch, this week’s column began to take shape.

When Forbes began compiling the list in 1982, there were only 13 billionaires, and all 400 individuals had a combined net worth of $169 billion. Only 21 individuals on the list had generated their wealth from the financial services industry. We were at the early stages of a bull market in stocks and bonds and the dawn of the revolution in information technology. As a result, energy, real estate, publishing, and inherited wealth predicated upon the manufacturing revolution were prominent on the original list.

Fast-forward to 2014, and the Forbes 400 list bears little resemblance to the inaugural edition. For starters, everyone on the list is now a billionaire. It takes a net worth of $1.8 billion just to make the top 400, and these individuals control an estimated $2.4 trillion. In other words, the wealth of the top 400 has increased by 1,311 percent since 1982, while the U.S. gross domestic product has expanded by 421 percent.

As you’d expect, the founders of Microsoft, Oracle, Amazon, Google, Facebook, Apple and other technology companies feature prominently on the most recent list. Major retail franchises and entertainment entrepreneurs are also well represented. The people who created America’s greatest businesses ought to become our richest citizens. This is how a capitalist economy works.

Despite the massive escalation in compensation for corporate managers, they aren’t well represented on the Forbes 400 list. While corporate boards are continuing to approve unconscionably lucrative compensation packages for the executive elite, those packages leave them far short of the billionaire class. Despite his vaunted place in corporate history, you will not find Jack Welch, former chairman of General Electric, on the list. If you haven’t created a major business or helped to invent an industry, or you haven’t inherited money, like the Waltons of Wal-Mart, there is only one other way to make the list: big-time investment management.

When you dig into the details of the Fortune 400 list, you’ll find 87 individuals from the financial services industry representing a combined wealth of $494 billion. My friend was right: 23 hedge fund managers and 17 private equity managers are on the list. In addition to George Soros and Carl Icahn, you’ll find Ray Dalio, the founder of the Bridgewater hedge fund complex, which has $170 billion under management, and Stephen Schwarzman, the founder of the alternative manager Blackstone, with $310 billion in assets.

Transfer of wealth

Why are money managers on the Forbes 400 list? Did they start a company that became a major corporation or introduce major new innovations or industries to the economy? Most of the money managers on the list made their initial fortunes investing other people’s money, whether it was trading securities or buying and selling companies. I’m not suggesting that these people aren’t talented, and there’s often strong evidence that they achieved superior investment performance, particularly in the formative years of their money management careers. However, successfully managing money isn’t akin to invention or entrepreneurship. Moreover, the vital ingredient in the vast accumulation of their wealth almost always turns out to be the uncanny ability to market to potential clients and gather assets. In due course, the fees and carried interest or bonuses on huge investment funds create the kind of wealth that puts one on the Forbes list.

Public pension plans, including North Carolina, have been a primary source of the transfer of wealth to elite money managers. In fact, North Carolina’s pension plan will give you some idea about how pension plans are helping to put money managers on the Forbes list. In the last fiscal year, the pension plan paid out $490 million in management and incentive fees, an increase of 18 percent over the prior fiscal year. Pension assets increased by 13 percent to $90.1 billion, and the pension earned a return of 9.5 percent. While taxpayers and pensioners enjoyed a reasonable year (thanks mostly to rising markets), money managers had an outstanding year. Life is good when your fees rise twice as fast your client’s assets. Fortunately for hedge fund and private equity managers, this trend will continue for many years to come.

Over the next decade, the Forbes 400 will probably add dozens of additional hedge funds, private equity professionals, and eventually their heirs to the list. The biggest firms are rapidly expanding into mass-market retail products and continuing to raise large institutional funds. For example, Blackstone just had a first closing of $17 billion on a new private equity fund, having just raised $18 billion for its latest real estate fund, which should help Mr. Schwarzman (No. 35 on the list), Hamilton James (No. 347) and Pete Peterson (No. 380) continue to move up the rankings. Apollo Global Management has raised similar sized funds assuring that Leon Black (No. 100), Joshua Harris (No. 259) and Mark Rowan (No. 285) will continue to move up among the rank of America’s billionaires.

Distorted economy

Why should you care? Money managers don’t produce real goods and services. Rather they are intermediaries who are supposed to help investors build savings. While this is a valuable role in any economy, it simply doesn’t deserve the same level of rewards bestowed on highly successful inventors and entrepreneurs. As a result, we are transferring huge amounts of wealth to people who don’t add much value to our economy. Moreover, our country’s wealth is being concentrated in a small group of people who have no interest other than making more money, and money should never be an end unto itself.

This ever-increasing accumulation of wealth in money managers is distorting our economy, our public policy and our politics. For example, it is this small group of men who have pumped up the for-profit school system over the past decade only to see it collapse under a heavy burden of student debt. These are the same folks pushing charter schools and the privatization of prisons. They have been systematically bending public policy to their economic interests. Moreover, it is the billionaires at a few hedge funds and private equity firms, along with a handful of industrialists, who get to decide who will be America’s political leaders. In the age of PACs and super PACs, the elite on the Forbes 400 are the gatekeepers to our public offices. The reign of the hedge fund and private equity managers may persist for a while, but things don’t end well when money rules.