A Call to Action For Both Disruptors and Incumbents
In “The New Dawn of Financial Capitalism,” Ashby Monk writes that the standards in the asset management industry have fallen so low that “doing good for investors means not doing anything bad.” The storm our industry is experiencing is blowing windows open for disruptors to exploit.
The incumbents that weather these changes most successfully will be the ones that do not just sit back and wait for these disruptions passively, but instead those that identify the trends to which their strengths play best, and actively pursue strategies to turn those imminent disruptions from threats to opportunities.
In our research, four significant opportunities for disruption stand out. In each, we see substantial room for value creation:
1. Despite emerging innovation, retail investors remain the most ill-served group in asset management. Few quality investment opportunities exist for individuals with less than $1 million in net worth, and yet these investors represent a $147 trillion market globally. We see many models focused on this niche, including robo-advisors and social trading firms such as Ayondo, Collective2, EToro, Sprinklebit, Zingals, and Zulutrade. Other emerging disruptors in this space include Artivest and Franklin Square Capital Partners, which offers retail investors direct access to hedge funds which historically individuals could not access. The typical user experience of playing a video game is engaging, addictive, and fun; the typical user experience of investing is not. The financial services industry can do more to learn from the engagement models of the consumer internet space.
2. Incentives need to be better aligned so that more value accrues to the ultimate beneficiaries, e.g., the retired employees, public servants, and taxpayers. Money holders repeatedly shared that they are willing to pay for true alpha performance. However, they are troubled when they end up paying disproportionate management fees and hidden costs regardless of performance. Under pressure from regulators, Blackstone Group LP recently disclosed that it could collect as much as $20 million annually from investors and companies in one of its buyout funds for services such as healthcare consulting and bulk purchasing. In response, leading public investors including CALPERS and New York State are aiming to uncover the hidden fees in their portfolio by augmenting their due diligence and governance processes. New types of intermediaries and industry consortium can support institutional investors, family offices and retail investors in uncovering the true cost structure in their funds. Ultimately, we believe this will help these allocators make better decisions on who to invest with and for how long. Creating and enforcing an industry-wide set of standards and benchmarks (such as the ILPA standards) will further help.
An even more radical, but common sense idea is to create business models that better align incentives of the money manager with the incentives of the investors. A rare example of such a business model, in an industry where money managers get paid billions even when investors lose money, is Adage Capital. This $23 billion hedge fund pioneered the approach of being paid only for alpha generation, i.e., Adage receives performance fees when they outperform the benchmark, and return money to investors when they miss the mark.
3. Helping the significantly underfunded US pension funds, who are unlikely to close their asset and liability gap, may require wrenching political reform. Liability matching is a forefront concern for both the $12 trillion defined benefit (DB) pension system and the US government. The IMF has warned that the drastic underfunding of US pension funds poses systemic risk to the global economy. At the opposite end of the spectrum, the emergence of defined contribution (DC) plans have shifted the market risk from the corporation to the individual, and simultaneously led to some uncomfortable questions to be asked about the quality of investment options available in corporate 401k plans, for example. An emerging pain point is balancing the needs of employees in one firm benefiting from a DB plan vs. those on a DC plan, without making either side feel disadvantaged.
A unique opportunity exists to help pension funds manage Defined Benefit and Defined Contribution plans simultaneously for the employees of one given employer, with consistent transparency and governance, as the industry evolves from the former to the latter. Some of the leading administrators are aiming to develop such an integrated platform.
4. A mass transition to a new generation of managers needs to happen without disruption to the system. The money manager owner class is disproportionately near retirement age. According to Imprint Group, “one third of assets currently managed are managed by men over the age of 60”. This creates a challenge in talent retention (because junior people see their path blocked); succession planning (when their path eventually gets unblocked); and eventually in business continuity. For example, Chris Shumway’s botched transition out of his hedge fund lead to huge simultaneous redemptions, followed by fire sales, and eventually the closure of an highly successful $8 billion hedge fund. In some instances, audit and risk oversight companies and technologies that help limited partners monitor founder partner departure risk can add value. But in many cases, they are monitoring stasis without understanding the internal leadership dynamics that will make or break these sensitive discussions.
Emerging money managers that can scale and innovate to provide the full spectrum of “jobs to be done” - technical, functional and emotional - will thrive in the future. These managers will not only embrace the professionalization of their own management teams, their economics will also benefit from capital fleeing managers who failed in their leadership challenges, particularly succession planning. The failure of Castle Harlan - a private equity firm with a 28 year track record - to transition its leadership economics exemplifies the risk of botched talent management. There is an emerging niche of service providers which help existing money managers grow their own leadership capacity and effectively manage the transition to a new generation of leaders. These management skills, the firms that develop them, and the firms that embrace them throughout their culture will be much in demand going forward.

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