In this third and final article in the current series, Nicholas Lyster and Amin Rajan conclude that, as markets have become disconnected from fundamental value drivers, the role of trusted adviser is gaining traction.

Good investment outcomes rely on clarity of beliefs and courage of convictions. But they are not sufficient. Asset managers also need a business model that enables them to see beyond 3% daily market fluctuation level that is the new norm.

Around 60% of asset managers need to reboot their business models, if they are to convert the current volatility into an investment opportunity for their end clients, according to the 2012 Principal Global Investors/CREATE survey, Market Volatility: Friend or Foe?*

For example, when asked whether high volatility offers a great opportunity to active managers, the survey responses were:
• 71% ‘yes’
• 22% ‘possibly’
• 7% ‘no’

There is no doubt that the current volatility cloud has a silver lining. However, when asked whether active managers can capitalise on it by delivering good returns net of fees, the replies were:
• 13% ‘yes’
• 54% ‘possibly’
• 20% ‘no’
• 13% ‘unsure’

The reported gap between opportunity and outcome is due to two factors. The first is the rapid ‘industrialisation’ of asset management. Over the past two decades, as it has grown into a mass market global industry, it has lost the skills that translate market ruction into investment opportunity. The second factor is clients’ own herd instinct that often ignores the cardinal investment rule: buy-low/sell-high.

Hence, investing during turbulent times can be scary. Clients have to walk a fine line between value investing and value traps. Similarly, asset managers have to walk a fine line between product push and reputational risk.

To help strike that balance, more and more asset managers are developing the role of a trusted adviser: somebody who is in the client’s inner circle of confidants; somebody who is open about things that matter most when deciding whether to capitalise on volatility – for example, the time period over which returns can materialise, and the nature of risks involved both within the period and at the end of it. Hence, changes are evident in three specific clusters.

The first cluster seeks to improve client proximity. Its key aims are: to understand clients’ dreams and nightmares; to sell products that the client needs; to elicit regular client feed back and act on it; to avoid unrealistic claims about returns; and to create in-house panels that protect client interests, via various checks and balances. The survey found that the degree of client engagement was a major factor in investment outcomes. Such engagement typically solicits new ideas, manages expectations, raises awareness, and avoids panic buying and selling.

The second cluster seeks to improve investment capabilities. Its aims are to develop fresh insights into the complex interaction between geo-politics and market dynamics; to identify return drivers during volatility phases; to develop a trained intuition about what works, what doesn’t and why; and to spot good buying opportunities.

The third cluster seeks to promote a better alignment of interests. Its aims are: to have meritocratic incentives; to avoid me-too products; to offer proactive investment ideas; and to minimise herd behaviour.

The trusted adviser role has come to the fore in the face of changing perception of risk. Historically, risk was measured as the probability of a given loss or the amount that can be lost with a given probability at the end of a defined investment horizon. This measure only considered the final result. However, since the bear market of 2000-02, investors have been hit by waves of losses within their investment horizons.

Many good investment products have not survived the resulting panic selling. ‘Wrong time’ risk has emerged like a bolt from the blue, only to be superseded by ‘regret’ risk when markets recovered sharply. The twenty-four hour news cycle has conspired against the time premium.

To avoid the prospect of another ‘lost decade’, the asset management industry is now undergoing its biggest makeover, as managers go from distant vendors to trusted advisers.

Nicholas Lyster is CEO, Principal Global Investors (Europe) and Amin Rajan is CEO, CREATE-Research

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