The new silver bullet in the age of uncertainty
In the second article in a new series, Nick Lyster and Amin Rajan argue that the credit crunch has exploded the myth that asset managers and pension consultants possess rare insights
Over the next three years, the fund pie will be noted for its subdued growth and dog fights will be inevitable, according to our latest report ‘Exploiting Uncertainty in Investment Markets'*.
Surprisingly, when asked to identify the models that will deliver maximum value to clients in the challenging environment of this decade, there are no clear standouts among the prevailing models, according to our survey respondents.
• In manufacturing, niche specialists (44%) and multi boutiques (41%) are at the top;
• In distribution, the chart toppers are multi asset class assemblers (47%) and advice channels (40%);
• In operations: third-party administrators (39%) and in-house capabilities (35%);
• In ownership: large partnerships (40%) and small partnerships (38%).
These seemingly low scores underline the fact that none had proved especially robust in the face of turbulence in the 2000s. Those asset managers who delivered great value did so because they had put clients first, irrespective of their models.
The after-shocks of the 2008 financial earthquake have left clients on shaky ground. Now, they need a high-touch approach: going beyond a three-way financial alignment (see case study) that includes service quality, risk controls, product innovation, and operational excellence.
Clients also now want to be assured that their asset managers are financially viable, intellectually credible, and operationally sustainable - in other words, people who understand the changing nuances of the investment landscape as much as the heartbeat of the client.
Having talented individuals is no longer enough: their support structures matter, too, in replicating past success. Accordingly, attention is moving from the nature of the model to the nature of activities that promote alignment within it. The virtues of a partnership structure are undeniable, even though its decision making process is slow. But other forms of ownership have distinct plusses that outweigh the minuses in the environment of this decade.
For insurance-owned managers, the negatives are: the perception of a sleepy un-innovative department of a life company, slow execution of change, and excessive emphasis on buy-and-hold investing. Their pluses are: access to captive assets, regular cash flow, and special expertise in liability matching and retirement products.
For bank-owned managers, the negatives are: product proliferation, me-too products, excessive bureaucracy, and high churn rate. Again, these are more than offset by global distribution, financial strength and brand recognition.
For publicly quoted managers, the negatives are: huge information management, star culture and excessive individualism. These are more than offset by better governance, stronger craft focus, and a lot of passion.
In each of these models, notable actions are being taken not just to emulate the kind of alignment inherent in the partnership setting but to go beyond it in the unique environment of the model. Existing models are a product of history and geography. None is especially scalable. Reinventing them root and branch is proving harder than adapting them incrementally and the winds of change are evident.
Moment of truth
Asset managers know that they cannot rely on market recovery to bail them out on this occasion. Accordingly, they have turned the spotlight on their product as well as service propositions, according to our study.
They are ramping-up expertise in asset allocation, product innovation and customised solutions; while replacing ‘bells and whistles' products with ones anchored in reality.
In distribution, they are raising service quality and technical collaboration with consultants and fund platforms.
The engine room of fund houses worldwide is breaking away from the past in two respects.
First, asset managers recognise they should push out only those products that are fit for purpose. In the last decade, clients who diversified outside their traditional long-only funds did so because they believed the uncorrelated returns story from their asset managers or they were enticed by the much publicised ‘prime mover' advantage, which turned the Harvard and Yale endowment funds into world class icons.
As a result, too many products flooded the market without due regard to client need, and most of them were neither tried nor tested, by time or events.
The risk models they used were too simple to accommodate ‘fat tail' events. For example, many hedge funds were seen as running a Ferrari with Citroen's brakes. Their replicators went a step further and promised outsized returns at a fraction of the cost. Risk was staked up like a wedding cake.
Now, there is new recognition that tough times can be the mother of invention, seeking new ways of meeting client needs, including ones they didn't know they had: ways that isolate innovation from novelty. New tools are being used to seek new product ideas and subject them to reality checks before new launches.
The second point of departure applies to the emerging service models. There are improvements in base line service standards for all clients. In addition, institutional clients are being segmented and offered a clear proposition based on their identified needs.
These changes are necessary, but not sufficient. Success will require asset managers to exercise ‘duty of care' in delivering five things: consistent returns, a deep talent pool, superior service, a value-for-money fee structure and a state-of-the-art infrastructure.
A fiduciary overlay
These factors have always mattered. But in the post crisis world, their delivery requires a decisive shift in asset managers' role, from distant vendors to close fiduciaries. Without it, clients know they will end up with the worst of both worlds: much pain and little gain.
The crisis has left client needs unaffected in some ways but profoundly changed in others.
The deliverables they want in this decade will remain the same as before but their tools will have to change, especially in Europe and the US.
Clients will continue to demand consistent returns, backed by service quality, a value-for-money fee structure and a state-of-the-art infrastructure. No change there.
But they want a step-change in the tools that are deployed. Promises in the past have fallen short of deliverables.
Asset managers are aiming to narrow the gap by developing a fiduciary overlay that.
• Counters behavioural biases that have cost their clients dear in the past;
• Stops asset managers from selling products that are not fit for purpose;
• Offers meritocratic incentives in which gains and pains are shared equitably;
• Develops common investment beliefs and time horizons;
• Delivers operational excellence via outsourcing.
In sum, the overlay seeks a three-way financial and non-financial alignment between:
• Asset managers and their clients;
• Asset managers and their professionals;
• Their professionals and clients.
The overlay also envisages two other things. One is openness on risks, charges and product integrity. The other is a proximity that allows managers to know their clients' dreams and nightmares so as to design the right solutions.
After heavy losses in the 2010s, clients are becoming more informed and demanding. Big outflows from the US mutual funds in the last quarter of 2009 are a case in point. Seeing enough chips on the table, a large cohort decided to cash in and head for the exit. Likewise, the switch in the institutional clients' portfolios suggests caution that describes the ‘new normal'.
Before committing their new money, clients are seeking: truth about time periods over which returns can materialise; truth about risks involved both within the period and at the end of it; truth about the compound erosion of their portfolios due to open and hidden charges; truth about products fit-for-purpose; and truth about the scalability of various business models while attracting new inflows.
Lambasted for snoozing through the last decade, regulators, too, will want to be seen to be rooting out malpractice. In Australia, Brazil, Denmark, Japan, the Netherlands, Sweden, the UK and the US, regulators are turning the spotlight on current practices as a prelude to tighter enforcement or yet more rules.
All this speaks to a simple imperative: clients want their asset managers to develop a fiduciary heritage that stops clients making stupid mistakes, and stops fund managers selling products not fit-for-purpose.
An important element of service is now about getting closer to clients so that their needs are identified and delivered. Likewise, an important element of the state-of the art infrastructure is about embedding checks and balances that ensure that clients are put at the heart of the business.
For asset managers, the latest crisis has proved a concealed opportunity to tackle things that have long conspired against client interests. Whether the ensuing changes will outlast the crisis that provoked them is an open question.
Nick Lyster is CEO of Principal Global Investors (Europe) and Prof Amin Rajan is CEO of CREATE-Research
* Available free from firstname.lastname@example.org