Date: 09.08.17 Category: Working For Change
PI: What impact will increased regulation have on the asset management industry in the future? Will it change the way the industry sells its products, or the type of products it sells, or the way it communicates with its clients? What will be the lasting impact, if any?
SEAN HAGERTY: There’s no doubt that regulatory change will be a major factor over the coming years and there are domestic and cross-border elements to this change. In the UK, the FCA is placing increased pressure on managers to be more transparent and accountable on cost, and that’s likely to have two key impacts. Firstly, it will expose any products or managers that can’t justify their fees; and secondly, it should result in more thoughtful and transparent communication designed to help investors make better decisions. Both of those outcomes should have a lasting, positive impact for investors. The cross-border picture is more complex. To take MiFID II and Brexit as two examples out of many, both of them will have big impacts on the way the industry sells products. Those changes will be long-lasting. The managers which engage actively with regulators and policymakers, rather than resisting change, will be the ones who prosper.
JEFF LEVI: The impact will be significant, particularly as asset management, in terms of resource of capital, moves from being more institutional-led to more defined contribution, or purely individual wealth-led. Regulation will rise significantly, with more emphasis on increased advice standards, more transparency, and more limitations in terms of the financial tools that can be used, such as leverage, and shorting, which some may feel is only for a sophisticated investor. All of this will squeeze different aspects for asset managers. The other big thing is as advice standards go up, you will tend to see consolidation in the decision-making process. Professional gatekeepers will play a bigger role, and they will act as purchasing agent, squeezing part of the industry. The final element is that brand and scale will become far more important for firms which want to be competitive in this new world. Good brands tend to communicate trust and quality, and buyers will increasingly flock to those brands that are well known and respected and you will see greater divergence between the high quality scale players and everyone else.
HAZEL MCNEILAGE: Carefully considered regulation designed to increase transparency and improve efficiencies across the industry is welcome. Asset managers are spending an increasing amount of time and resource on regulation and associated compliance activities. We see this trend continuing, particularly with the impact of upcoming regulations such as MiFID II. Many may look to fund administrators to support them with the administrative burdens so that they can focus on the business of managing money for their clients. Being able to look ahead and anticipate evolving client needs will be important for asset managers as they focus on developing innovative products. With each new rule comes an opportunity for innovation in line with the new state of play – ultimately driving positive enhancements across the industry.
PI: There is greater pressure than ever before on fees and costs. How can the industry ensure that there is a successful alignment of interests in this area?
MCNEILAGE: A key focus for asset managers going forward will be to ensure their products align to a client’s current needs, but more importantly can adapt effectively to changing circumstances. By being able to develop innovative products that can help investors ‘solve a need’, asset managers can support an alignment between their clients’ and managers’ business models. Fundamental to alignment of interest in terms of fees and costs is transparency. Beyond that, managers need to be able to demonstrate value for money in terms of the services they provide.
LEVI: This is a really difficult one. The industry has been built on an asset-based pricing model, which has some elements of alignment – the business only generates value if it makes money for the investor. But naturally, capital markets are aligned with that, and even if they are generating sub-optimal value they can make a profit. Asset owners will vote with their feet, and for the most part, money can be moved reasonably easily with limited friction costs. That will continue to be the case, particularly with the rise of secondary markets, we’ll continue to see the biggest source of alignment through money and motion. But we are seeing a lot of asset managers exploring new models, such as performance models, or trying to align pricing with the time horizon of the investment, or the way in which the investor actually likes to make money. This requires thinking about asset management with a long-term view, which is a challenge. But I do think we’ll see a lot of managers take it upon themselves to re-draw their pricing models.
HAGERTY: We’re really pleased to see increased pressure on costs, because costs are a major impediment to investing success, and margins in the fund management industry are higher than you would expect given the number of market participants. Whenever fund management companies take fees from their clients and use those fees to pay external shareholders, there is an inevitable conflict of interest. We’re sometimes unpopular for raising this fact, but it is a fact. The only way to remove that conflict of interest is to align the interests of investors and shareholders. One way to do that is through a mutual structure.
PI: How might asset management business models evolve over the next decade?
LEVI: If I had to guess, in 5 to 10 years, leading asset management businesses will look extremely different than they do today. You’ll see groups of scale players who focus on one or two areas and do it very well, and you’ll continue to see beta shops. There will also be firms that are vertically integrated, which offer advice directly to buyers and other intermediaries through technology and other tools. I think we’re going through a pretty significant paradigm shift right now. If you look at where margins end up if firms just do what they do without making significant changes, we see margins dropping significantly. There will either be massive changes in how people are paid across the industry, or firms will have to transform their business models. They will have to think about how they generate revenue and service clients, and how they generate efficiencies.
HAGERTY: Predicting the future is notoriously difficult, but some of the trends we’ve seen lately look likely to continue. For example, I’d expect preferred partnership models to proliferate, with distributors and providers playing to their respective strengths in large-scale, global relationships. I also think ETFs will continue to gain market share. They’re a very efficient way to offer broad market exposure and, as investors and providers get more comfortable with ETFs as a product structure, their share of flows is likely to increase. The story of the ETF industry so far has shown that assets tend to gravitate towards trusted providers with scale and proven expertise, and that’s likely to continue.
MCNEILAGE: This question needs to be considered in the context of a structural shift from defined benefit to defined contribution pensions, more flexible work patterns, an ageing population and rapid technological advance. These factors are expected to lead to continuing industry consolidation and the need for ongoing product innovation, for example to address both the pre- and post-retirement investment needs of defined contribution plan participants.
PI: What role might technology play?
HAGERTY: Technology is a major enabler of better investment outcomes and it can work in lots of ways. At the most fundamental level, we’re using technology every day to maximise the efficiency of our processes, so that we can invest accurately and cost-effectively for our clients. We’re using it to analyse and manage risk, and we’re using it to make sure we’re communicating appropriately with investors. That will continue to evolve and improve as technology gets better. The key is not to use technology for technology’s sake. The most successful product providers and intermediaries of the future will be the ones who always keep client needs in mind. They will make sure that their service is as intuitive as possible and combine smart use of technology with the right amount of humanity – because, ultimately, our clients are human beings.
MCNEILAGE: We have already seen the rise of robo-advice bringing changes to the intermediary marketplace and Blockchain starting to fundamentally change a variety of processes. We believe robotics, natural language and artificial intelligence can help deliver increased productivity, innovative products and enhanced service to our clients. Northern Trust invests heavily in technology – investing more than $2.4 billion in technology from 2016-2018. We also have a number of innovation centres focused on connecting the exploration of emerging technology with the real needs of our client base. Several of our innovation centres follow the principles developed by our Client & Partner Experience lab in Chicago. As a global corporation, the investments we make can be deployed for all our clients across the regions, meaning they benefit from our global investment.
LEVI: Most managers have underinvested in tech, so the first big wave is cleaning up the way in which businesses run, and being able to clean up and harness data across the business to deliver alpha and to create a more customised client experience. A lot of firms are focusing on that now, and it will be a multiyear effort, which will have a profound effect. Historically, the client experience has been predicated on a sophisticated buyer that is looking for data that they can punch into their model. That is akin to selling medical devices to a doctor. I think you’ll see much more emphasis on creating an unforgettable client experience that actually makes finance enjoyable. You’ll see a lot of emphasis on creating interfaces and tools, which make it less painful to think about retirement wealth and savings and investing. This has the potential to very quickly change the way people think about investing and hopefully improve their savings and ability to help them prepare down the road. The final wave would be the ability to generate outcomes and alpha, so using big data and information to basically find new sources of alpha. That will be a big part of what the future of asset management will look like. I think technology will allow firms to go beyond the traditional data sources that are used in asset management.
PI: What sort of asset management firms will succeed? Those who are flexible? Those with size and scale? Those offering innovative products?
MCNEILAGE: Managers who succeed will be clear in terms of the market segments they are targeting and they will work closely with clients on product innovation, grounded in robust investment capabilities. They will make smart use of technology, provide value for money to clients and clearly articulate this.
HAGERTY: All of those things are important – and more. You always have to be flexible – we only have to look at the regulatory backdrop and the unpredictable nature of markets to know that. Size and scale will definitely help, but size sometimes brings complexity, which can lead to increased risk. So the key as you grow is to maintain simplicity of thought and purpose. Innovation is great, as long as it’s done with investors’ needs in mind – niche, specialist products or products that only exist because they can exist are unlikely to be sustainable at scale in the long term. But above all of the things you’ve mentioned, companies that are successful in the long term will have an unwavering focus on clients and a track record of delivering on their promises.
LEVI: A lot of the brands that exist today will remain, but you will see new organisations that define their value propositions in different ways. I think you’ll see computer-driven or algorithmic-driven players emerge, and players who position themselves not just as alpha providers but outcome providers, with the focus much more on allocation and construction than security selection. You’ll have firms, that specialise in specific bio needs, rather than every asset manager being one size fits all. As the world becomes more individual, there are a lot of buyers who don’t want that sophisticated process-driven scale, they’ll buy for other reasons. Those who sell to the millennials will look different to those who sell to the retirement generation. You’ll start to see more separation in business models, but you’ll have to be a top one or two or three player to succeed.
PI: What other trends or themes will have an impact on the evolution of the industry?
LEVI: There are two other big things that tie in to these topics. One is the rise of beta. The rise of passive investing has been a big driver of growth, in part because individuals like access to expensive index exposure, and in part because there has been more emphasis on outcome and allocation. So the beta is being sold as a product to the end investor, but will also input into another product. One of the underlying themes is this notion of searching for lower cost in an environment where fees actually do impact returns. There is also skepticism over active management in the industry that’s quite challenging. More than half of active management hasn’t outperformed as you would expect statistically. I also think educational systems are increasingly pushing or emphasising efficient markets, so you’re seeing some of those larger areas get displaced by beta. That trend will in certain places continue and in others will slow. Asset managers who have scale beta offerings in place will benefit, as will those who can use those capabilities and repackage them as something else. We are also expecting pretty significant large-scale M&A in the next several years, as firms seek ways to make scale and reduce cost.
HAGERTY: I think we’re in a period of lower-than-average market returns for the next few years, and this could have a few implications. What it should do is cause managers to double down on reducing cost and improving efficiency – because the lower your total return is, the harder the bite of costs. What I hope doesn’t happen is that lower market returns lead to increasingly complex products that seek to generate returns in ways that are hard for investors to understand. That doesn’t sound like a recipe for long-term success to me.
MCNEILAGE: We have seen a large increase in the adoption of environmental, social and governance (ESG) investing over recent years. For example, according to Arabella Advisers, the total assets of investors who opted for
Sean Hagerty, Chief Executive Officer, Vanguard Asset Management
Jeff Levi, Principal, Casey Quirk by Deloitte
Hazel McNeilage, Managing Director for EMEA, Northern Trust Asset Management