Appendix
1: Full List of The Jobs to Be Done in Asset
Management
\label{appendix-1-full-list-of-the-jobs-to-be-done-in-asset-management}
Technical Jobs to be
Done
\label{technical-jobs-to-be-done}
A Money Manager must do all of the functional Jobs below at an
acceptable level just to be in business. The bare minimum Functional
Jobs investors required from Money Managers is to optimize the risk
adjusted return or the Sharpe ratio of the investment. Thus investing is
a constant trade off between “make more money” and “do not lose
money.”
Don’t lose money. As Daniel Kahneman documents
in
Thinking
Fast and Slow, people hate to lose money more than they care about
making money. Even aside from the emotion, some institutional investors
and many individuals (e.g., those close to retirement) have a structural
imperative to hate losses more than they value gains. Sophisticated
Money Holders understand that sometimes they are going to lose money.
However, they expect Money Managers to have clear reasons and to perform
within the expectations of their investment strategy, as well as to make
money overall over time. Smart Money Managers address this need by
focusing on risk adjusted return offerings, and articulating the
tradeoff between risk and returns. For example, Bridgewater’s Pure Alpha
strategies allows investors to select different volatility levels based
on their risk preference. Goldman Sachs Asset Management and Pacific
Investment Management Company, LLC offer similar strategies.
Exceed
Investments offers a set of index funds whose market differentiation is
a structure to minimize the odds of a loss beyond a defined limit.
An example of a vulnerable category of funds which does not do this Job
well: Highly leveraged, high volatility, high concentration hedge funds,
which cannot withstand withdrawals during significant down years. The
average lifespan of a hedge fund
is
5
years; within a three-year period about one-third of hedge funds
disappear.
Make more money. Some investors look to optimize for highest
returns above all over time. These are typically ultra high net worth
individuals or sovereign wealth funds that can tolerate volatility for
long periods of time. Such investors might invest in the most nascent of
asset classes,
e.g.,
names,
income,
finance,
currencies,
timber,
farms/ranches,
art,
collectibles,
or carbon
credits. Fund managers that optimize for high returns over other Jobs
include activist investors such Bill Ackman at Pershing Square and Bruce
Berkowitz at Fairholme Funds. At a Boys & Girls Harbor Investment
Conference, Bill Ackman and Ray Dalio debated the merits of each other’s
strategies; Dalio warned that Ackman’s investment strategy poses
“risk
of ruin”. Warren Buffett’s value-focused Berkshire Hathaway also
optimizes for returns, and may accept as a result short term
underperformance.
Particularly in their earlier years, all of these investors offered
relatively poor diversification. Ackman, Berkowitz, and Buffett would
all argue that there exist great stock pickers who can beat the market,
but such investors only have a few good ideas per year, so therefore
they should make only a few trades per year.
Similarly, angel investing is the highest-returning asset class we’re
aware of, with median returns of
18% to
54% across 12 academic studies, but offers very poor liquidity,
transparency, and predictability.
Thus to get highest returns, Money Holders have to tolerate likely short
term volatility, lack of liquidity, and/or lack of diversification.
Charge minimum fees and expenses. Recent Money Manager
underperformance, the low growth economic environment, and underfunded
pension funds all force Money Holders to pay more attention to fees.
Vanguard is the role model and king of the low expense Money Manager
industry, both because of their focus on indices which require minimal
research, and their highly unusual status as a Money Manager which
is
owned
by its own funds. ETFs (BlackRock iShares) are another way to
dramatically lower expenses. Discount brokers
like
Charles
Schwab and
TD
Ameritrade were disruptive in their day to full service brokers; many
believe robo-advisors are the modern equivalent.
There is room for new businesses that shed light on the true costs and
expenses of fund management. While hedge fund and private equity funds
typically report management fees and performance fees, there is little
transparency around other fees charged to funds such as legal,
compliance, entertainment, custodian, and even middle office, which can
add up to up 100 basis points. Companies such
as
AcordIQ,
Addepar,
Novus,
and
Vitrio
help aggregate and expose the costs embedded in a fund as part of
holistic portfolio governance.
Functional Jobs to
be Done
\label{functional-jobs-to-be-done}
Certain Money Holders have unique needs which create windows for new
business models to emerge.
Protect my job security. “ No one ever got fired for buying
IBM.” Institutional investors tend to cluster-invest in the same large
funds, even though
many
studies
show that small funds consistently outperform large funds. This could be
because allocators all want access to the best funds. On the other hand,
it could be argued that there is less career risk if allocators follow
the crowd and invest in the same funds their peers
select;
career
risk is one of the biggest enemies of alpha.
Inflation protection. Today we live in a low inflation
environment and some economists argue that we are entering a
deflationary period. However, that was not always the case, and unlikely
to be always the case. Inflation-linked (IL) bonds, real estate, and
commodities provide an inflation hedge. In some markets used to high
inflation such
as
China
and India, Money Holders choose to put a significant portion of their
wealth into gold. Notably, the demand for gold in India and China is
also driven by cultural preferences as well; see Experiential Needs
below.
Provide diversification. The ultimate diversification is to own
an index of the entire market, but of course then tautologically you
will only get market returns. The traditional diversified portfolio is
the 60%/40% equities bond mix. Alternatively the risk parity model is
a typically passively managed portfolio that performs well in most (but
not all) economic environments - growth, inflation and deflation. A
number of funds offer such an option: The institutional market is
dominated by Bridgewater’s All Weather (~$90bln), AQR
Risk Parity fund (~$25bln) and Invesco Balanced Risk
Allocation (~$20bln); Greenline Partners’ Tax Efficient
Risk Balanced approach is an emerging manager in the family office
space. However, investors need to think about diversification
holistically beyond just investing in public markets, i.e., how to
incorporate venture capital and real estate or even art in their
portfolio. We see few solutions in the market-place that allow for true
diversification across both public and private markets.
Minimize taxes. Life insurance is a tax-protected way to
protect your heirs’ interests. Puerto Rico marketed its bonds as
“triple tax free” (exempt from federal, state and local income taxes),
which made them very attractive, until Puerto Rico admitted they could
not actually pay them off.
Greenline
Partners offers a risk parity model, not common among Money Managers
serving institutions, which focuses on tax minimization by understanding
the long term impact of deferring taxes and overlaid with a unique tax
loss harvesting methodology. Some robo-advisors provide automatic tax
loss harvesting to help investors minimize taxes as well.
Provide access to specific sectors. Traditional investment
consultants offer very granular tools to diversify along your axis of
choice. Some Money Managers offer highly targeted funds for Money
Holders who want carefully defined target sector exposure. For
example,
Motif
Investing enables individuals to invest in a given theme (a “motif”),
e.g., all stocks that benefit from a theme of the ‘connected car’.
Investors can effectively custom-design their own fund according to any
theme that they believe in. Investors may also look for target exposure
to markets that they cannot easily trade, such as frontier markets which
may not be open to regular investors.
So
Himalaya
Capital offers access to Chinese Equities, and Shehzad
Janab’s
Daman
Investments hedge fund provides access to the UAE market. These
targeted opportunities can at times hugely outperform developed markets.
However, investors should be prepared to accept both local economic as
well as political risk as well as lack of diversification.
Match returns to liabilities and obligations. Often Money
Holders do not care about the highest return per se, but want
assurance that they can meet their financial obligations. This is
particularly true for retirees as well as many institutional investors
such as pension funds and endowments. If you invest in dividend funds,
utilities, bonds, or many types of rental real estate, you know with
(relatively high) confidence that you will get predictable incoming cash
payments. For example, two of the biggest municipal bond funds which
provide predictable, tax-free income are T. Rowe Price Tax Free High
Yield Fund and American High Income Municipal Bond Fund. Bond funds,
however, in a low interest environment provide low returns and often do
not match investor liabilities. Alternatively, commercial and
multi-family real estate funds, which provide a blend of annual
dividend-like payment and opportunity for appreciation at exit, have
also become a popular investment for liability matching.
Achieve political goals. Many public Money Holders have defined
public service goals, e.g., invest in companies in their home state.
Similarly, most sovereign funds look for way to invest in economic
development in their local economy. We see a few Money Managers that
specifically target the unique needs of sovereign funds creating
customized investment strategies.
Self-discipline. Just as with losing weight, there is no
shortcut to success in investing. Money Holders need to start by putting
money aside, which requires discipline. There are business models that
encourage such discipline, including certain retirement pools, e.g.,
401Ks, which charge penalties for early withdrawal. This has two
benefits: it allows the Money Manager responsible for the 401Ks to make
long-term investments, and it also increases the likelihood that the
retail investor will have more money for retirement. Many advisors
automatically withdraw each month an investment allowance from their
customers’ bank account.
Major catastrophe protection. A non-trivial percentage of
investors want
to
protect
themselves in the event of major
economic
dislocation.
They might invest in a backup luxury second home, ideally in a place
like Vancouver; Canada is a stable country with rule of law and low
vulnerability to climate change. Portable wealth (gold, jewelry,
diamonds) allows you to cross borders easily in the event of social
turmoil. Certain local businesses (e.g., a restaurant or farm) can
provide income even in the midst of turmoil. Mormons keep a twelve-month
supply of food and essentials in their basement as insurance. We are not
aware of a financial product offering that addresses this unique need
more systematically. Catastrophe insurance (e.g., flood insurance)
provides protection against narrowly defined protections. However, in
the event
of
The
End of the World As We Know It (the disaster prepper’s worst-case
scenario), traditional financial services providers will probably not be
reliable.
Emotional Jobs to Be
Done
\label{emotional-jobs-to-be-done}
While performing the functional Jobs is the bare minimum requirement for
a Money Manager, and special purpose Jobs target specific customers,
Jobs at the emotional, experiential and social level create a deep
connection with clients and lead to “sticky” relationships. The
ability to do these Jobs well marks those firms which are likely to stay
in business for the long-term.
According
to Amanda Tepper, CEO of
Chestnut
Advisory Group: “contrary to conventional wisdom, investment
performance alone does not drive asset flows. While there is a clear
relationship between the two, investment performance accounts for only
about 15% of the reason for placing money with managers. We found
correlations between trailing three-year returns (the primary metric
most institutional investors follow) and subsequent one-year net capital
inflows ranging from only 0.24 among small and mid-cap equity managers
to just 0.04 for Global Fixed Income managers. ”
We have found that customers may not clearly express or even openly
admit that they value Emotional, Experiential and Social Jobs in some
cases higher or as high as the functional Jobs. However, the Money
Managers that perform these experience and social Jobs well consistently
attract more assets.
Customer service. Customer service is important for both retail
and institutional investors. In the retail space, in addition to
expertise, investors value empathy in their financial
advisors:
“An
empathetic financial advisor is one who truly listens to clients,
ensuring they feel understood and who demonstrate that they care.” One
expert in private wealth management says that advising people about
money is being “part financial expert, part shrink, part friend and
confidant, and part entertainer.”
In the institutional space, hedge fund
Bridgewater
has a bend-over-backwards-for-clients internal culture; a large client
service department staffed with investment level professionals; and its
own analytics team whose research and advice is provided to clients at
no extra charge. Additionally, ability and availability to provide
insight into “how the world works” from an investment perspective
earns Bridgewater loyal long-term investors. The high importance Money
Holders place on customer service calls into question the viability of
technology-only investment platforms (like robo-advisors) and the black
box hedge fund model of
“give
me your money and wait for your annual report.”
Transparency.
ARK
Invest offers several ETFs with near-real-time exposure of their
individual trades. Goldman Sachs recently announced that it will share
some of
its
secret
sauce with its clients.
One of the current problems that institutional investors face is lack of
adequate transparency and control of all costs charged by manager, which
was dramatized by the Madoff fraud. According to
the
New
York Times, “Earlier this year, a senior executive of the California
Public Employees’ Retirement System, the country’s biggest state pension
fund, made a surprising statement: The fund did not know what it was
paying some of its Wall Street managers.” The investment agreements
that institutional investors sign often give a lot of leeway to managers
to pass questionable costs to the LPs. Recently, the Carlyle group
passed on their limited partners (LPs) the cost
of
a
opportunity for companies such as
Vitrio,
Novus,
and
AcordIQ
which provide a technology platform to institutional investors for
systematic oversight of fund managers. Some industry champions, such as
Scott Evens, CIO of one of the largest public pension fund, New York
City Retirement Systems, are leading the way to establishing best
practices around a revamped due-diligence and governance process.
Education. The fastest growing sector in investment research
for the last two decades are
expert
networks, e.g.,
GLG. They slice
out what many analysts traditionally considered their investment edge –
a proprietary group of expert relationships built up over years in the
business - and offers direct access to experts on any possible category,
for on-the-fly education.
There is no ongoing education requirement for many professional
allocators, and most HNW private investors and retail investors have
little to no education in contemporary investing, observes Joseph
Reilly, a family office consultant in Greenwich, Connecticut. This
aspect of asset management often gets lip service, but it is essential
to retaining clients. The smaller investor, and even large family
offices, cannot possibly keep current with the changes in the way the
markets are traded. They have very little understanding of the arms race
around esoteric asset packaging that runs rampant on the Street, or how
high frequency trading actually affects the market. It falls to Money
Managers to educate their clients on how new strategies work, despite
their clear conflict of interest. This goes for professional allocators
as well, many of whom think portfolio management started with Markowitz
and ends with Swensen. Recognizing good change from simply more risk is
the Job of education. One of the secrets of Bridgewater’s growth to be
the world’s largest hedge funds is their enormous investment in what is
effectively free consulting for their clients.
Social welfare. Millennials and women – both growing forces
in the pool of Money Holders – are more likely than their past
generations and men in general to value doing good in addition to doing
well. According to Patrice Viot Coster, COO of AXA Investment Managers
Research: “People may want to express openly who they are through their
investments: I am what I invest.” We do not mean the philanthropic
activities of hedge fund billionaires, but the general desire of the
average investor to positively impact the world through their
investments. Social impact or “green” bonds offer a creative way for
investors to invest in companies offering returns linked to achieving
certain defined social impacts. Numerous “double-bottom-line” socially
responsible investors promise Money Holders the option of earning high
returns while they achieve certain socially desirable goals. Generation
Investment Management (co-founded by former Vice President Al Gore) has
over $7B under management, and differentiates from competition in large
part based on their focus on “sustainability research”. According
to
Cambridge
Associates, private impact investment funds – specifically private
equity and venture capital funds – that pursue social impact objectives
have recorded financial returns in line with a comparative universe of
funds that only pursue financial returns.
Religious beliefs. Religious institutions (e.g., the Catholic
Church and Mormon Church), observant individuals, and some family
offices look for investments that are compliant with their religious
views. For example, consider Omar Bassal, head of asset management
for
MASIC,
a shariah-compliant family office based in Saudi Arabia. He structures
investments in public equity, private equity and real estate to comply
with Islamic restrictions regarding business activities and interest,
among other things. Omar sees “a shortage of investment funds that are
specifically designed for investors that want to invest in a way that is
consistent with Sharia laws.” Shariah-Compliant funds are prohibited
from investing in companies which derive income from the sales of
alcohol, pork products, pornography, gambling, military equipment or
weapons. Additionally, Shariah compliant funds cannot employ
conventional leverage or sell shares short. Instead of investing in
bonds, notes, T-bills and other conventional fixed income products,
Shariah compliant investors favor trade finance funds, leasing funds and
Sukuks (income-generating asset backed pools) which provide a substitute
for the portion of investors’ portfolios that carries less risk than
equity markets and provides yield.
Access to networks, e.g., celebrity investors. Some investors
buy Berkshire Hathaway stock just to get an invitation to their annual
meeting. In public markets, value investors puzzle at the valuations
Elon Musk’s companies,
Tesla
and
SolarCity,
command and attribute that partially to Musk’s star appeal. Some VCs
choose to invest in a company in part to build a stronger relationship
with existing prominent VC investors. Also, in venture capital,
companies that have raised money from celebrities often attract people
eager to put money in just to have a shot at rubbing shoulders with the
glitterati.
STAR
Angel Network formalizes this by offering membership exclusively to
athletes and celebrities. Star athlete Torii Hunter and Wall Street
Veteran Ed Butowsky formed the
exclusive
Clubhouse
Investment Club for the same reason: the founders hope that Hollywood
and sports celebrity members’ access to social media will contribute to
stronger performance of their investments.
Personal use and passion. Some investors put money into art,
wine, jewelry, antiques, stamps, or even a sports team, more for
personal use than as a financial investment. Baby boomers in the west,
who have paid their mortgage and put their children through college, as
well as the nouveau riche in Russia and China, are driving the
value of
“passion
investments” up.
Many investors put money into equity crowdfunding sites
(AngelList,
CircleUp,
FundersClub,
OurCrowd,
SeedInvest,
etc.) and product crowdfunding sites
(Indiegogo)
because of the excitement and ego gratification of investing in a small,
unknown, exciting startup company. The same is true for individual angel
investments made by retired business people who enjoy continued
engagement and the energy of small start ups. The hope of a financial
payout is not the only motivator for these angels who also invest their
personal time and experience. One such angel shared that he invests in
all the startups his buddies put money into, because he does not want to
be the only one left out at the local bar who is not toasting to the one
startup they invested in with a 20X return.
Coolness and exclusivity. The best example of this is Bernie
Madoff. He was a fantastic salesman and would be one of the world’s best
Money Managers, if not for the unfortunate fact that he was a fraud. He
persuaded his clients that he had only limited capacity, and was only
able to let in his friends/contacts as investors. His perceived
“exclusivity” made investing in his firm all the more attractive.
Certain
investors
prefer
to allocate in “cool”, “selective”, hedge funds, as opposed to
boring mutual funds, precisely because hedge funds are not broadly
marketed to the hoi polloi. Similarly, in the past few years
actors and professional athletes (neither historically groups known for
investing acumen) have been piling into seed-stage technology investing
because it’s seen as “cool”.