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.
Terminology
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