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3. Standard compensation models motivate Money Managers to add more assets under management, but size often hurts returns. This contributes to the ‘winner take all’ trend in which we see steadily growing concentration of AUM into the largest money managers (See Picture 3). For example, venture capital funds earn on average two-thirds of their compensation from management fees, not carry. However, there is an inevitable tension between size and returns. Large hedge funds over time hit liquidity limits and start impacting market pricing when they trade, losing their ability to exploit arbitrage opportunities. Similarly, large VCs earn lower returns than small VCs, who in turn earn lower returns than angel investors; angels writing small checks have among the highest returns of any asset class. Of course, it is true that large size does create certain proprietary advantages, e.g., some large fund of funds negotiate preferential management fees from funds in which they invest.
The largest asset managers capture nearly all net flows into the US market; net flows to other managers are down significantly.
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A money manager must do all of the technical jobs at an acceptable level
just to get in the game. At a minimum, investors require money managers
to be able to deliver risk-adjusted alpha at lower cost. We see possible
disruptions where funds are highly leveraged, high volatility and highly
concentrated. These funds cannot meet the minimum level of technical
proficiency and cannot withstand withdrawals during significant down
years. We see the average lifespan of a hedge fund is
5
years;
within a
three-year
period
about
one-third of hedge funds disappear.
The cookie cutter approach to money management is no longer adequate.
Today’s investor base is global and diverse along culture, gender and
demographic lines driving unique investments needs. As a result, money
managers will have to be able to adapt their business models and offer
appropriately scaled service levels at the right cost.
Jobs at the emotional level create a deep connection with investors and
lead to enduring relationships and improved economics through lower
churn for managers and allocators alike. The ability to do the emotional
jobs well can transform an asset manager into an institution - likely to
scale and to stay in business for the long-term. We have found that
customers may not clearly express or even openly admit that they value
“emotional jobs” at the same level or higher to well known functional
jobs. However, the money managers that perform these jobs well - jobs
that may be more “social” or “experiential” - will consistently
attract more assets.
-
Customer service is critical for both retail and institutional
investors.
Investors look for money managers with ability to make sense of the
cacophony of information and disparate investment advice. Further, they
need highly customized and often personalized help to shape their
investment strategy, sorting signal from the noise. The high importance
money holders place on customer service, therefore, calls into question
the viability of technology-only investment platforms and the black box
hedge fund model of
“give
me your money and wait for your annual
report.”
In the institutional space,
Bridgewater
has a “bend-over-backwards-for-clients” internal culture. Bridgewater
offers both large, highly skilled client service teams and a proprietary
analytics team. The client service teams are staffed with professionals
capable for being portfolio managers in their own right, while the
analytics research is provided to clients at no extra charge. 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.”
Joseph
Reilly Jr., a private wealth advisor in Greenwich, Connecticut, says
that advising people about money is being “part financial expert, part
shrink, part friend and confidant, and part entertainer.”
-
Investors want transparency into what is actually happening
with their money. As the Millennials begin to invest their own funds
or become CIOs at asset allocators, they will expect the same “at
your fingertips” accessibility to their portfolio that they now have
from their Facebook account. Some money managers are beginning to
adjust:
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
trading sauce with its clients.
Regulatory requirements and painful past experiences in money management
(e.g., Madoff and other high profile frauds) have put transparency high
on the priority list for institutional investors as well. 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 often give enormous leeway to managers to
pass questionable costs on to their investors.. Recently, the Carlyle
Group passed on their limited partners the cost of
a
$115 million settlement of a insider trading lawsuit - clearly a
failure of its own internal management. The opacity of these
arrangements creates an opportunity for companies such as
Vitrio,
Novus,
and
AcordIQ
which provide technology platforms to institutional investors for
systematic oversight of fund managers. Scott Evans, CIO of the New York
City Retirement Systems, one of the largest public pension systems in
the US, and other industry leaders are beginning to establish best
practices around a revamped due-diligence and ongoing governance process
to increase their insight and systematically build transparency in their
investment programs.
-
Money holders want to learn how to be better investors: The
under-resourced and often “relatively” underpaid institutional
investor, the family office, and the smaller retail investor all find
it difficult to keep current with market trends. They may have little
understanding of the arms race around esoteric asset packaging rampant
on Wall Street, or how high frequency trading actually affects the
market. It falls to money managers to educate investors on how new
strategies work, although potential conflicts of interest abound. The
fastest growing sector in investment research for the last two decades
are
expert
networks, e.g.,
GLG. These
networks displace what some managers considered their investment edge
– a proprietary group of expert relationships built up over years in
the business. The expert networks offer direct access to experts on
any possible category for on-the-fly education. Northern Trust’s
private wealth practice has built an analytical platform that educates
high net worth individuals about designing customizable portfolios
specific to their unique circumstances. Both these companies are
strengthening the decision-making capabilities of their clients.
-
Investors increasingly desire to put their money where their
heart is - whether it is based on social consciousness, religious
views or a hobby: 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. Religious
institutions (e.g., the Catholic Church and Mormon Church) and
religious individuals/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. At the hobby end of the spectrum, some investors
buy Berkshire Hathaway stock just to get an invitation to their annual
meeting. This is also true of those who put money into art, wine,
jewelry, antiques, stamps, or even a sports team. These investments
are often more for personal utility than financial investments. We see
empty nester Baby Boomers in the West and nouveau riche in Russia and
China driving up the value of these
“passion
investments.”
That is not to say that all disruptive opportunities exist only in the
emotional realm. In the retail space, investors have technical
requirements - from wealth transfer to estate planning - that are
broadly served by the private wealth managers. Interestingly, we found
three specific functional needs that stand out as an underexplored
opportunities for emerging disruptors:
-
Retail investors increasingly care about how much money they
take home, not the gross return - before taxes & fees - reported on
their investment statement. Poorly managed taxes and transaction
costs can
kill
investment returns. As protection, robo-advisors provide automatic
tax loss harvesting to help investors minimize taxes. Some specific
investment instruments also aim to minimize taxes, e.g., life
insurance for inheritance planning and municipal bonds are
tax-advantaged products. An emerging manager,
Greenline
Partners,
offers
a risk parity model not common among money managers serving
institutions. The Greenline solution focuses on tax minimization by
understanding the long term impact of deferring taxes and overlaid
with a unique tax loss harvesting methodology.
-
Helping savers apply self discipline is also a simple but
effective way to add differentiation. Just as with losing weight,
there is no shortcut to amassing investable assets. 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.
-
Thematic investing takes the guesswork out of the equation:
Traditional investment consultants offer very granular tools to
diversify along the investment spectrum. Today, 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.
for example,
Himalaya
Capital offers access to Chinese Equities. Shehzad Janab’s
Daman
Investments hedge fund provides access to the UAE market. These
targeted opportunities can, at times,
outperform
developed markets. However, investors should be prepared to accept
local economic risk, political risk, low liquidity and well as lack of
diversification within the themes.
At the institutional level, separately managed accounts and special
purpose investment vehicles are gaining popularity as two ways to meet
allocators technical or functional needs. For this group of investors,
often with substantially divergent investment needs, we note two
pressing needs:
-
Pension funds and endowments struggle to match liabilities and
obligations. Institutional investors, in particular, 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. This functional need is dominating internal
conversations at investors that are working to meet long term
obligations. Bond funds, a traditional source of cash flows for asset
& liability matching, clearly struggle to offer critical returns in
low or near-zero interest rate environments. Alternatively, commercial
and multi-family real estate funds, which provide a blend of annual
dividend-like payments and opportunity for appreciation at exit, have
also become a popular investment for liability matching.
-
Political and “public good” goals rank high on the agenda of
government-owned money managers. Special interests, preservation of
power, and economic development goals can all be part of government
investor agendas at city, state and federal levels. Such investors may
have defined public service goals, e.g., invest in companies in their
home state or support minority owned businesses. Similarly, sovereign
funds in the Middle East look for ways to invest locally in industries
that decrease their dependence on the energy sector. Yet, we see few
money managers that specifically target the unique needs of these
public or quasi-public managers on these dimensions.
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Appendix 1: Full List of The Jobs to Be Done in Asset Management
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Appendix 2: The Universe of Investable Assets
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David Teten (New York, NY) is a Partner with a leading New York venture capital fund. David previously advised clients such as Goldman Sachs Special Situations Group, Icahn Enterprises, LLR Partners ($1.4b fund), Birch Hill Equity Partners (C$2B fund), and other institutional investors. David has financial interests in such fintech companies as Addepar, Distil Networks, Earnest Research, Indiegogo, Ionic Security, Sure, and Socure. He has been a serial CEO at the intersection of financial services and technology since 1999. David previously founded Circle of Experts, an investment research firm sold to Evalueserve, the largest pure-play knowledge process outsourcing firm. He writes at teten.com. Contact:
[email protected]
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Even low-cost retail advisors like
Charles
Schwab,
Fidelity,
and
Vanguard
are not immune to pressure from the yet lower cost robo-advisors. Change
is happening so fast that disruptors are now potentially being
disrupted.
In a
tepid
more about
minimizing
costs, taxes, and fees, rather than unpredictable top-line returns.
Schwab is looking to take market share from traditional wealth managers
and full service brokers, while
Wealthfront
works on snaring Merrill Lynch clients. Meanwhile,
Alibaba
and other social media giants are busy working to capture Schwab’s
business. (See Picture 1). As of June 2015, Alibaba had amassed over
$115
billion in assets under management in just two years.
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“If you want to build a ship, don't drum up people to collect wood and don't assign them tasks and work, but rather teach them to long for the endless immensity of the sea.” Antoine de Saint-Exupery
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Our research suggests the the power base will finally shift to Money
Holders from Money Managers. We see four main ways that global economic,
social and political trends are driving this massive power shift:
Rapid technology innovation is generally positive for most money
holders and will provide an opportunity to differentiate for
intermediaries and money managers . Technology, and specifically the
internet, will drive greater transparency, ease of use, and efficiency,
while creating new opportunities for funds looking to generate alpha.
But technology is neither a panacea nor fault-free, e.g., the 2015
Flash
Crash and Bank of New York Mellon’s
mutual
fund settlement problems. Overall, technology will both raise assets
and reduce fees, but it will not be a competitive differentiator on its
own. Some startups will target upgrading institutions’ investing
process: consider
Earnest
Research, which analyzes transaction data and other non-traditional
data sets for investment research, and
AcordIQ,
a platform that institutional investors can use to gain better control
and governance of funds they are invested in. Other will target
individuals:
Long
Game is turning gamblers into investors.
A slow growth economy has negative impact on most of the asset
management industry and is forcing accountability on money managers.
Many of the leading macro investors, including
George
Soros,
Ray
Dalio and
Vanguard’s
Chief Economist, Joe Davis, are pessimistic about global growth
outlook. One of the biggest implications for asset management is that
underfunded pension funds will have a difficult time meeting their
return expectations. Another implication is that the large money
managers that collected hefty fees from riding the long term “beta”
growth wave in the 80s and 90s will have a difficult time justifying “2
and 20” fees in a lackluster economy.
As women and millennials become key allocators, they create a
new group of underserved customers with new unmet values and
expectations . Womens’ $14 trillion in assets today is projected to
reach $22 trillion by 2020,
according
to a Family Wealth Advisors Council white paper. Meanwhile, millennials
are coming of age in the work force. The new decision makers will expect
the industry to reflect both better gender balance and be more
accessible everywhere, and will invest in money managers who do not look
like Warren Buffett. Internal diversity forces an organization’s members
to question their assumptions more aggressively, think more deeply, and
are less likely to generate bubbles, according to
research
by Professor Sheen Levine. Further, these two groups (women and
millennials) tend to invest differently than the past generation of
older
men.
According
to the Spectrum
Group,
Millennials,
for example, are both more risk-averse and more socially conscious than
past generations when selecting investments. In addition, having come of
age during the financial crisis, millennials have a negative brand
perception of some of the traditionally dominant financial services
companies.
Geopolitical risk around the world leads to capital flight to
safe havens. Political volatility is typically not good for savers and
allocators as it tends to destroy asset value. Regional political
instability and the fear of totalitarian regimes exists in China,
Russia, the Middle East, and South America, which now have millions of
well-educated and newly wealthy citizens that look to protect themselves
and their nest eggs.
The
IMF reports that we are seeing the first net private capital outflows
in emerging markets since 1984. For example, according
to
Bloomberg,
money is quietly leaving China at the fastest pace in at least a decade:
an estimated $300 billion in financial outflows in the six months
through March 2015. This is double the capital ($150 billion) that
exited Russia prompted by the Ukraine crisis. Overall, the economic
outlook in the US is modest, but the country is relatively stable
despite political dysfunction, and remains the most attractive on a
relative basis. Just as immigrants streamed to Ellis Island, the wealth
of the newly prosperous emerging markets will increasingly seek refuge
in the United States, as well as other perceived safe havens such as
Singapore and Switzerland.
The Money Manager
of the Future
\label{the-money-manager-of-the-future}
Based on the problems and global trends uncovered in our research, we
outline below the five characteristics that will differentiate the
winning money manager of the future (See Picture 5):
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The Jobs To Be Done in Asset Management
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The Macro Trends Forcing Change on Our Industry
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The Money Manager of the Future
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This study would not have been possible without the collaboration and support from The
Boston Consulting Group. We also want to thank the research, technology and editorial team who supported us during this study: Greg Durst, Jen McPhillips, Jenny Wong, Charles McLaughlin, Michael Rose, and James Ebert.
We give special thanks to the dozens of industry leaders that contributed to this study with their insight. All errors herein are our responsibility. Among those we interviewed: Dr Rania Azmi, International Investment Expert & Speaker
Tom Bartman, Senior Researcher, Forum for Growth and Innovation, HBS
Omar Bassal, Head of Asset Management, Mohammed Alsubeaei & Sons Investments Company
John Casey, Chairman of CaseyQuirk
Mary Cahill, CIO of Emory
Charles Dooley, CEO of AcordIQ
Greg Durst, COO of Marto Capital, former Endeavour, CEO of Africa
Grant Easterbrook, Co-founder, Dream Forward Financial
Charles “Charley” D. Ellis, Founder, Greenwich Associates
Scott Evens, CIO of New York Pension System
Steven Fradkin, President, Wealth Management, Northern Trust
Jeff Hunter, CEO and Founder of Talentism
Omar Kodmani, CEO of Permal
Charles McLaughlin, Principal, National Security Practice, Censeo Consulting Group
Gary Markovitz, CEO of Business Innovation Partners
Carol Morely, CEO of the Imprint Group
Joseph W. Reilly Jr., family office consultant
Peter Sanchez, CEO Northern Trust Hedge Fund Services
Harry Singh, CFO at AIG Operations
Dhivya Suryadevara, CIO of GM Pension Fund
Amanda Tepper, Chestnut Advisory Group
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Double click to add an Abstract
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by Katina Stefanova, David Teten, and Brent Beardsley. \href{http://DisruptInvesting.com}{DisruptInvesting.com}
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"One summer day, probably in the 1870’s, friends of a major short-seller got together on the shores of Newport, Rhode Island, where they admired the enormous yachts of New York’s richest brokers. After gazing long and thoughtfully at the beautiful boats, the short seller asked wryly, ‘Where are the customers’ yachts?’”
Jason Zweig, in his introduction to Fred Schwed’s 1940’s Wall Street classic, “Where Are the Customers’ Yachts – A Good Hard Look at Wall Street”
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Brent Beardsley (Chicago, IL) is a Senior Partner in the Boston Consulting Group. Brent is the Global Head of BCG’s Wealth and Asset Management Segment, and lead co-author for BCG’s annual global wealth management and asset management reports. He is also the global topic area leader for Marketing and Sales topics in the Financial Services sector. Since joining BCG, he has worked with a broad set of sales and market topics such as customer segmentation and data analytic strategies, sales force effectiveness / multi-channel strategies, and product innovation development and management, leveraging behavioral economics principles. Contact:
[email protected]
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Terminology
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“If you want to build a ship, don’t drum up people to collect
wood and don’t assign them tasks and work, but rather teach them to long
for the endless immensity of the sea.”
Antoine
de Saint-Exupery
The investment industry is today very immature in its human capital
management, with high turnover, minimal succession planning, and a
strikingly homogeneous work force. As founders age and investor
demographics change, the established investment firms will face
a
how to attract, develop and retain talent. “Purpose-driven companies,”
says Jeff Hunter, CEO of
Talentism,
“are more likely to have employees who exhibit cohesive behavior and
act in the best interest of the company and the investors.” Thus, we
foresee a professional CEO role emerging in asset management: She will
be fully focused on leadership as distinct from the traditional CIO and
VP of Sales. It’s worth noting that some of the leading asset management
firms, including D.E. Shaw and Blue Mountain, are leading the way by
being very proactive and mindful about managing their culture and
principles.
The Jobs
To Be Done in Asset
Management
\label{the-jobs-to-be-done-in-asset-management}
Christensen popularized the idea of analyzing a company by looking at
the
“Jobs
to Be Done” needed by its clients. Most money managers think their
main job is returns, but they are wrong.
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 (very
low) correlations between trailing three-year returns (the primary
metric most institutional investors follow) and subsequent one-year net
capital inflows.”
Managers will still have to cover the basics like meeting return
expectations at the right risk levels with the proper internal controls
(the technical jobs to be done). The true opportunity set, however, lies
in connecting deeply with investor needs (their functional and emotional
jobs to be done). The winners in asset management need to provide
targeted customization at scale (a functional job). See Picture 8 for a
summary, and see
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”One summer day, probably in the 1870’s, friends of a major
short-seller got together on the shores of Newport, Rhode Island, where
they admired the enormous yachts of New York’s richest brokers. After
gazing long and thoughtfully at the beautiful boats, the short seller
asked wryly, ‘Where are the customers’ yachts?’”
Jason Zweig, in his introduction to Fred Schwed’s 1940’s
Wall Street classic, “Where Are the Customers’ Yachts – A Good Hard
Look at Wall Street”
If investors complained about Wall Street 140 years ago, they’re howling
now.
Asset management is about to go through a particularly dramatic period
of disruption, for three reasons. First, the industry is extremely
profitable, and excess profit pools attract competition. According to
BCG,
total 2014 annual industry profits were $102 billion globally, flowing
from notably high operating margins of 39%. Second, financial
technology venture capital is exploding: CB Insights
reports
that $19.1b was invested in fintech companies in 2015, vs. $3.9b in
2013. And third, a number of global trends as well as changes unique to
the asset management industry are coinciding to force change onto even
the most recalcitrant. The technology and social revolution,
globalization, the emerging markets’ wealth, the increased role of
women, and the millennials’ changing tastes are an irresistible force
meeting a moveable object: traditional asset management industry
structure.
When we talk about disruption, we are using the formal definition of
Disruptive Innovation popularized by Harvard professor
Clay
Christensen: “an innovation that helps create a new market and
value network, and
eventually disrupts an existing market and value network (over a few
years or decades), displacing an earlier technology.” Examples in asset
management include index funds
(Vanguard);
ETFs
(iShares);
crowdfunding
(AngelList);
discount/online brokerages
(Charles
Schwab); and online wealth management
(Wealthfront,
Betterment).
(See Picture 1).
Traditionally, asset management changes slowly. Of the $280 trillion of
investable assets globally, approximately 50% (~$140
trillion) is invested in real estate and cash – which were also the
most popular asset classes in the 1800s. The next most popular asset
classes are insurance and treasury bonds, which were disruptors in the
1600s.
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Picture 4: Macro Trends Impacting Money Management
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Picture 5: The Five Characteristics of a Successful Money
Manager
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Picture 6: The $280 Trillion Global Universe of
Investable Assets
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Picture 7: Passives and Specialties Continue to Win a
Disproportionate Share of Net Flows.
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Picture 8: The Hierarchy of Jobs to be Done
Jobs to be done must incorporate technical, functional, and emotional
benefits.
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Picture 10. Defined Terms
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Picture 8: The Hierarchy of Jobs to be Done
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Picture 3: US Net Cash Flows to Money Managers
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Picture 4: Macro Trends Impacting Money Management
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Picture 2: Relative (Gross & Net) Hedge Fund Performance Over Time
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Picture 5: The Five Characteristics of a Successful Money Manager
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Picture 1. Current Examples of Disruption in the Investing Industry
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Picture 7: Passives and Specialties Continue to Win a Disproportionate Share of Net Flows.
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Picture 6. The $280 Trillion Global Universe of Investable Assets
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The Peculiar Asset Management Industry
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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”.
diff --git a/layout.md b/layout.md
index e69de29..a229266 100644
--- a/layout.md
+++ b/layout.md
...
figures/image18/image18.png
textbfAbout_the_Auth.html
David_Teten_New_York_NY__.html
div_b_Brent_Beardsley_b__.html
textbfTable_of_Conte.html
figures/image24/pic1.png
blockquote_p_i_One_summer__.html
p_If_investors_complained_about__.html
p_Asset_management_is_about__.html
p_When_we_talk_about__.html
p_Traditionally_asset_management_changes__.html
h1_class_ltx_title_section_id_peculiar__.html
p_Asset_management_is_a__.html
p_1_b_The_asset__.html
p_b_2_The_asset__.html
figures/image22/image22.png
3_Standard_compensation_models_motivate__.html
figures/image20/image20.png
p_b_4_Money_managers__.html
p_b_5_The_financial__.html
p_b_6_The_b__.html
p_b_7_The_investment__.html
The_Macro_Trends_Forcing_Change__.html
p_Global_tectonic_shifts_technology__.html
figures/image21/image21.png
p_Our_research_suggests_the__.html
p_b_Rapid_technology_innovation__.html
p_b_A_slow_growth__.html
p_b_As_women_and__.html
p_b_Geopolitical_risk_around__.html
The_Money_Manager_of_the__.html
p_Based_on_the_problems__.html
figures/image23/image23.png
p_b_Use_technology_to__.html
p_b_Create_and_sustain__.html
p_b_Manage_integrated_risk__.html
p_b_Generate_new_sources__.html
p_nbsp_br_p__1.html
p_b_Invest_in_talent__.html
p_nbsp_br_p__2.html
If_you_want_to_build__.html
p_The_investment_industry_is__.html
The_Jobs_To_Be_Done__.html
p_Christensen_popularized_the_idea__.html
p_Managers_will_still_have__.html
figures/image19/image19.png
p_Jobs_to_be_done__.html
p_A_money_manager_must__.html
p_The_cookie_cutter_approach__.html
p_Jobs_at_the_emotional__.html
ul_li_b_Customer_service__.html
p_Investors_look_for_money__.html
ul_li_b_Investors_want__.html
p_Regulatory_requirements_and_painful__.html
ul_li_b_Money_holders__.html
ul_li_b_Investors_increasingly__.html
p_That_is_not_to__.html
ul_li_b_Retail_investors__.html
ul_li_b_Helping_savers__.html
p_At_the_institutional_level__.html
ul_li_b_Pension_funds__.html
ul_li_b_Political_and__.html
p_b_A_Call_to__.html
p_In_a_href_http__.html
p_The_incumbents_that_weather__.html
p_In_our_research_four__.html
p_b_1_Despite_emerging__.html
p_b_2_Incentives_need__.html
p_An_even_more_radical__.html
p_b_3_Helping_the__.html
p_A_unique_opportunity_exists__.html
p_b_4_A_mass__.html
p_Emerging_money_managers_that__.html
div_b_Terminology_b_br__.html
figures/image12/terms.png
Appendix_1_Full_List_of__.html
p_b_i_Technical_Jobs__.html
p_A_Money_Manager_must__.html
p_b_Don_t_lose__.html
p_An_example_of_a__.html
p_b_Make_more_money__.html
p_Particularly_in_their_earlier__.html
p_Similarly_angel_investing_is__.html
p_Thus_to_get_highest__.html
p_b_Charge_minimum_fees__.html
p_There_is_room_for__.html
p_b_i_Functional_Jobs__.html
p_Certain_Money_Holders_have__.html
p_b_Protect_my_job__.html
p_b_Inflation_protection_nbsp__.html
p_b_Provide_diversification_b__.html
p_b_Minimize_taxes_b__.html
p_b_Provide_access_to__.html
p_b_Match_returns_to__.html
p_b_Achieve_political_goals__.html
p_b_Self_discipline_nbsp__.html
p_b_Major_catastrophe_protection__.html
p_b_i_Emotional_Jobs__.html
p_While_performing_the_functional__.html
p_We_have_found_that__.html
p_b_Customer_service_b__.html
p_In_the_institutional_space__.html
p_b_Transparency_nbsp_b__.html
p_One_of_the_current__.html
p_b_Education_nbsp_b__.html
p_There_is_no_ongoing__.html
p_b_Social_welfare_b__.html
p_b_Religious_beliefs_b__.html
p_b_Access_to_networks__.html
p_b_Personal_use_and__.html
p_Many_investors_put_money__.html
p_b_Coolness_and_exclusivity__.html
Appendix_2_The_Universe_of__.html
p_To_frame_our_analysis__.html
figures/img/img.png
figures/image12/image12.png
p_The_value_of_the__.html
p_The_relative_size_of__.html
figures/image25/image25.png
p_Even_low_cost_retail__.html
p_b_Global_Investable_Assets__.html
p_To_estimate_global_Investable__.html
ul_li_Defined_the_universe__.html
ul_li_Defined_Money_Holders__.html
ul_li_Ignore_in_this__.html
ul_li_Included_real_estate__.html
ul_li_Categorized_insurance_and__.html
ul_li_Excluded_leverage_as__.html
p_b_Disclaimers_and_Disclosures__.html
p_The_opinions_expressed_herein__.html
p_Katina_Stefanova_is_an__.html
p_David_Teten_has_a__.html
p_Brent_Beardsley_has_been__.html
p_b_Contributors_b_br__.html
This_study_would_not_have__.html
diff --git a/p_1_b_The_asset__.html b/p_1_b_The_asset__.html
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...
1. The asset management industry collectively plays a near-zero-sum game. By contrast, most industries are positive sum: if you eat a great steak dinner, it doesn’t imply that others have to eat hamburger. In asset management, each new Money Manager that is able to generate Alpha (returns above the passive benchmark performance) normally does so at the expense of other Money Managers who underperform. Your own investment’s value may change because of a change in value of the underlying asset and/or market preferences. However, few investors can impact the value of the underlying asset, except for typically private equity and venture capital investors. And only celebrity investors like George Soros can influence market preferences. In fact, it is mathematically impossible for the median investor in a given publicly-traded sector to beat a low-cost index of that sector, after expenses. Money managers playing a positive-sum game include those who focus on well-developed sectors for which indices are not readily available (e.g., private companies, frontier markets) and/or nascent asset classes (e.g., internet domain names, lifetime individual income, litigation finance, virtual currencies, cryptocurrencies, divorce loans, receivables, patents, frequent flyer miles, timber, farms/ranches, art, collectibles, or carbon credits.
diff --git a/p_A_Money_Manager_must__.html b/p_A_Money_Manager_must__.html
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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.”
diff --git a/p_A_money_manager_must__.html b/p_A_money_manager_must__.html
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--- /dev/null
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A money manager must do all of the technical jobs at an acceptable level just to get in the game. At a minimum, investors require money managers to be able to deliver risk-adjusted alpha at lower cost. We see possible disruptions where funds are highly leveraged, high volatility and highly concentrated. These funds cannot meet the minimum level of technical proficiency and cannot withstand withdrawals during significant down years. We see the average lifespan of a hedge fund is 5 years; within a three-year period about one-third of hedge funds disappear.
diff --git a/p_A_unique_opportunity_exists__.html b/p_A_unique_opportunity_exists__.html
new file mode 100644
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--- /dev/null
+++ b/p_A_unique_opportunity_exists__.html
...
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.
diff --git a/p_Amanda_Tepper_Chestnut_Advisory__.html b/p_Amanda_Tepper_Chestnut_Advisory__.html
new file mode 100644
index 0000000..ff55e96
--- /dev/null
+++ b/p_Amanda_Tepper_Chestnut_Advisory__.html
...
Amanda Tepper, Chestnut Advisory Group
diff --git a/p_An_even_more_radical__.html b/p_An_even_more_radical__.html
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--- /dev/null
+++ b/p_An_even_more_radical__.html
...
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.
diff --git a/p_An_example_of_a__.html b/p_An_example_of_a__.html
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--- /dev/null
+++ b/p_An_example_of_a__.html
...
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.
diff --git a/p_Asset_management_is_a__.html b/p_Asset_management_is_a__.html
new file mode 100644
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--- /dev/null
+++ b/p_Asset_management_is_a__.html
...
Asset management is a highly unusual and somewhat baffling industry. We see seven main examples of just how peculiar our industry is, relative to other industries:
diff --git a/p_Asset_management_is_about__.html b/p_Asset_management_is_about__.html
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--- /dev/null
+++ b/p_Asset_management_is_about__.html
...
Asset management is about to go through a particularly dramatic period of disruption, for three reasons. First, the industry is extremely profitable, and excess profit pools attract competition. According to BCG, total 2014 annual industry profits were $102 billion globally, flowing from notably high operating margins of 39%. Second, financial technology venture capital is exploding: CB Insights reports that $19.1b was invested in fintech companies in 2015, vs. $3.9b in 2013. And third, a number of global trends as well as changes unique to the asset management industry are coinciding to force change onto even the most recalcitrant. The technology and social revolution, globalization, the emerging markets’ wealth, the increased role of women, and the millennials’ changing tastes are an irresistible force meeting a moveable object: traditional asset management industry structure.
diff --git a/p_At_the_institutional_level__.html b/p_At_the_institutional_level__.html
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--- /dev/null
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...
At the institutional level, separately managed accounts and special purpose investment vehicles are gaining popularity as two ways to meet allocators technical or functional needs. For this group of investors, often with substantially divergent investment needs, we note two pressing needs:
diff --git a/p_Based_on_the_problems__.html b/p_Based_on_the_problems__.html
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--- /dev/null
+++ b/p_Based_on_the_problems__.html
...
Based on the problems and global trends uncovered in our research, we outline below the five characteristics that will differentiate the winning money manager of the future (See Picture 5):
diff --git a/p_Brent_Beardsley_has_been__.html b/p_Brent_Beardsley_has_been__.html
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--- /dev/null
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Brent Beardsley has been a consultant in the past and possibly in the future to some of the leading global financial services institutions mentioned above.
diff --git a/p_Carol_Morely_CEO_of__.html b/p_Carol_Morely_CEO_of__.html
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Carol Morely, CEO of the Imprint Group
diff --git a/p_Certain_Money_Holders_have__.html b/p_Certain_Money_Holders_have__.html
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--- /dev/null
+++ b/p_Certain_Money_Holders_have__.html
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Certain Money Holders have unique needs which create windows for new business models to emerge.
diff --git a/p_Charles_Charley_D_Ellis__.html b/p_Charles_Charley_D_Ellis__.html
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index 0000000..4c7e4c8
--- /dev/null
+++ b/p_Charles_Charley_D_Ellis__.html
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Charles “Charley” D. Ellis, Founder, Greenwich Associates
diff --git a/p_Charles_Dooley_CEO_of__.html b/p_Charles_Dooley_CEO_of__.html
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index 0000000..b80f006
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Charles Dooley, CEO of AcordIQ
diff --git a/p_Charles_McLaughlin_a_href__.html b/p_Charles_McLaughlin_a_href__.html
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index 0000000..8c77f6d
--- /dev/null
+++ b/p_Charles_McLaughlin_a_href__.html
...
Charles McLaughlin, Principal, National Security Practice, Censeo Consulting Group
diff --git a/p_Christensen_popularized_the_idea__.html b/p_Christensen_popularized_the_idea__.html
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Christensen popularized the idea of analyzing a company by looking at the “Jobs to Be Done” needed by its clients. Most money managers think their main job is returns, but they are wrong. 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 (very low) correlations between trailing three-year returns (the primary metric most institutional investors follow) and subsequent one-year net capital inflows.”
diff --git a/p_David_Teten_has_a__.html b/p_David_Teten_has_a__.html
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David Teten has a financial interest in Addepar, Earnest Research, and Indiegogo.
diff --git a/p_Dhivya_Suryadevara_CIO_of__.html b/p_Dhivya_Suryadevara_CIO_of__.html
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Dhivya Suryadevara, CIO of GM Pension Fund
diff --git a/p_Dr_Rania_Azmi_nbsp__.html b/p_Dr_Rania_Azmi_nbsp__.html
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Dr Rania Azmi, International Investment Expert & Speaker
diff --git a/p_Emerging_money_managers_that__.html b/p_Emerging_money_managers_that__.html
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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.
diff --git a/p_Even_low_cost_retail__.html b/p_Even_low_cost_retail__.html
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...
Even low-cost retail advisors like Charles Schwab, Fidelity, and Vanguard are not immune to pressure from the yet lower cost robo-advisors. Change is happening so fast that disruptors are now potentially being disrupted. In a tepid global economy, money holders worry more about minimizing costs, taxes, and fees, rather than unpredictable top-line returns. Schwab is looking to take market share from traditional wealth managers and full service brokers, while Wealthfront works on snaring Merrill Lynch clients. Meanwhile, Alibaba and other social media giants are busy working to capture Schwab’s business. (See Picture 1). As of June 2015, Alibaba had amassed over $115 billion in assets under management in just two years.
diff --git a/p_Gary_Markovitz_CEO_of__.html b/p_Gary_Markovitz_CEO_of__.html
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Gary Markovitz, CEO of Business Innovation Partners
diff --git a/p_Global_tectonic_shifts_technology__.html b/p_Global_tectonic_shifts_technology__.html
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Global tectonic shifts - technology revolution, globalization, the increased role of women and millennials and a generational turnover among chief investment officers - are an irresistible force meeting a moveable object: the traditional asset management industry structure. (See Picture 4 for a summary.) Meanwhile, asset management shows the traditional earmarks of an industry ripe for disruption — most obviously, unhappy customers and very profitable incumbents.
diff --git a/p_Grant_Easterbrook_Co_founder__.html b/p_Grant_Easterbrook_Co_founder__.html
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Grant Easterbrook, Co-founder, Dream Forward Financial
diff --git a/p_Greg_Durst_COO_of__.html b/p_Greg_Durst_COO_of__.html
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Greg Durst, COO of Marto Capital, former Endeavour, CEO of Africa
diff --git a/p_Harry_Singh_CFO_at__.html b/p_Harry_Singh_CFO_at__.html
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Harry Singh, CFO at AIG Operations
diff --git a/p_If_investors_complained_about__.html b/p_If_investors_complained_about__.html
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If investors complained about Wall Street 140 years ago, they’re howling now.
diff --git a/p_In_a_href_http__.html b/p_In_a_href_http__.html
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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.
diff --git a/p_In_our_research_four__.html b/p_In_our_research_four__.html
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In our research, four significant opportunities for disruption stand out. In each, we see substantial room for value creation:
diff --git a/p_In_the_institutional_space__.html b/p_In_the_institutional_space__.html
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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.”
diff --git a/p_Investors_look_for_money__.html b/p_Investors_look_for_money__.html
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Investors look for money managers with ability to make sense of the cacophony of information and disparate investment advice. Further, they need highly customized and often personalized help to shape their investment strategy, sorting signal from the noise. The high importance money holders place on customer service, therefore, calls into question the viability of technology-only investment platforms and the black box hedge fund model of “give me your money and wait for your annual report.” In the institutional space, Bridgewater has a “bend-over-backwards-for-clients” internal culture. Bridgewater offers both large, highly skilled client service teams and a proprietary analytics team. The client service teams are staffed with professionals capable for being portfolio managers in their own right, while the analytics research is provided to clients at no extra charge. 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.” Joseph Reilly Jr., a private wealth advisor in Greenwich, Connecticut, says that advising people about money is being “part financial expert, part shrink, part friend and confidant, and part entertainer.”
diff --git a/p_Jeff_Hunter_CEO_and__.html b/p_Jeff_Hunter_CEO_and__.html
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Jeff Hunter, CEO and Founder of Talentism
diff --git a/p_Jobs_at_the_emotional__.html b/p_Jobs_at_the_emotional__.html
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Jobs at the emotional level create a deep connection with investors and lead to enduring relationships and improved economics through lower churn for managers and allocators alike. The ability to do the emotional jobs well can transform an asset manager into an institution - likely to scale and to stay in business for the long-term. We have found that customers may not clearly express or even openly admit that they value “emotional jobs” at the same level or higher to well known functional jobs. However, the money managers that perform these jobs well - jobs that may be more “social” or “experiential” - will consistently attract more assets.
diff --git a/p_Jobs_to_be_done__.html b/p_Jobs_to_be_done__.html
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Jobs to be done must incorporate technical, functional, and emotional benefits.
diff --git a/p_John_Casey_Chairman_of__.html b/p_John_Casey_Chairman_of__.html
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John Casey, Chairman of CaseyQuirk
diff --git a/p_Joseph_W_Reilly_Jr__.html b/p_Joseph_W_Reilly_Jr__.html
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Joseph W. Reilly Jr., family office consultant
diff --git a/p_Katina_Stefanova_is_an__.html b/p_Katina_Stefanova_is_an__.html
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Katina Stefanova is an investor in AcordIQ and Long Game; is a former Bridgewater Senior Executive; and continues to have financial interests in Bridgewater.
diff --git a/p_Managers_will_still_have__.html b/p_Managers_will_still_have__.html
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Managers will still have to cover the basics like meeting return expectations at the right risk levels with the proper internal controls (the technical jobs to be done). The true opportunity set, however, lies in connecting deeply with investor needs (their functional and emotional jobs to be done). The winners in asset management need to provide targeted customization at scale (a functional job). See Picture 8 for a summary, and see Appendix 1 for a detailed discussion of the jobs to be done in asset management.
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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.
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Mary Cahill, CIO of Emory
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Omar Bassal, Head of Asset Management, Mohammed Alsubeaei & Sons Investments Company
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Omar Kodmani, CEO of Permal
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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 $115 million settlement of a insider trading lawsuit. This create an 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.
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Our research suggests the the power base will finally shift to Money Holders from Money Managers. We see four main ways that global economic, social and political trends are driving this massive power shift:
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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.
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Peter Sanchez, CEO Northern Trust Hedge Fund Services
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Regulatory requirements and painful past experiences in money management (e.g., Madoff and other high profile frauds) have put transparency high on the priority list for institutional investors as well. 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 often give enormous leeway to managers to pass questionable costs on to their investors.. Recently, the Carlyle Group passed on their limited partners the cost of a $115 million settlement of a insider trading lawsuit - clearly a failure of its own internal management. The opacity of these arrangements creates an opportunity for companies such as Vitrio, Novus, and AcordIQ which provide technology platforms to institutional investors for systematic oversight of fund managers. Scott Evans, CIO of the New York City Retirement Systems, one of the largest public pension systems in the US, and other industry leaders are beginning to establish best practices around a revamped due-diligence and ongoing governance process to increase their insight and systematically build transparency in their investment programs.
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Scott Evens, CIO of New York Pension System
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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.
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Steven Fradkin, President, Wealth Management, Northern Trust
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That is not to say that all disruptive opportunities exist only in the emotional realm. In the retail space, investors have technical requirements - from wealth transfer to estate planning - that are broadly served by the private wealth managers. Interestingly, we found three specific functional needs that stand out as an underexplored opportunities for emerging disruptors:
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The cookie cutter approach to money management is no longer adequate. Today’s investor base is global and diverse along culture, gender and demographic lines driving unique investments needs. As a result, money managers will have to be able to adapt their business models and offer appropriately scaled service levels at the right cost.
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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.
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The investment industry is today very immature in its human capital management, with high turnover, minimal succession planning, and a strikingly homogeneous work force. As founders age and investor demographics change, the established investment firms will face a talent crisis and will have to rethink how to attract, develop and retain talent. “Purpose-driven companies,” says Jeff Hunter, CEO of Talentism, “are more likely to have employees who exhibit cohesive behavior and act in the best interest of the company and the investors.” Thus, we foresee a professional CEO role emerging in asset management: She will be fully focused on leadership as distinct from the traditional CIO and VP of Sales. It’s worth noting that some of the leading asset management firms, including D.E. Shaw and Blue Mountain, are leading the way by being very proactive and mindful about managing their culture and principles.
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The opinions expressed herein are only those of the authors individually, and do not represent the views of any of their employers or of any other institution with which they are affiliated.
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The relative size of each pool changes over time due to investor preferences, which is driven by growth expectations, risk perceptions, total available liquidity, and investors’ idiosyncratic views. For example, one of the best examples of disruption is the low cost index fund movement, pre-eminently Vanguard. As a result of the sector’s growth, the proportion of assets managed by money managers in traditional active core asset classes has shrunk dramatically from nearly 60% of assets in 2003 to less than 40% today. This will likely accelerate, as net flows into traditional active core asset classes are negative (See Picture 7).
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The value of the universe of investable assets has increased over time, fueled fundamentally by population growth (which typically expands the value of the underlying corporations) and economic growth. This type of growth is also referred to as beta return or the above-cash market return. To benefit from such returns, investors do not require much investment acumen other than smart diversification.
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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.
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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.
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Thus to get highest returns, Money Holders have to tolerate likely short term volatility, lack of liquidity, and/or lack of diversification.
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To estimate global Investable Assets, we made the following assumptions:
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To frame our analysis and understand where disruption has happened in the past, we analyzed the global flow of assets from money holders, to intermediaries (advisors), and on to money managers. Collectively, we call this the universe of investable assets, which totals today roughly $280 trillion:
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Tom Bartman, Senior Researcher, Forum for Growth and Innovation, HBS
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Traditionally, asset management changes slowly. Of the $280 trillion of investable assets globally, approximately 50% (~$140 trillion) is invested in real estate and cash -- which were also the most popular asset classes in the 1800s. The next most popular asset classes are insurance and treasury bonds, which were disruptors in the 1600s.
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We give special thanks to the dozens of industry leaders that contributed to this study with their insight. All errors herein are our responsibility. Among those we interviewed:
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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.
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When we talk about disruption, we are using the formal definition of Disruptive Innovation popularized by Harvard professor Clay Christensen: “an innovation that helps create a new market and value network, and eventually disrupts an existing market and value network (over a few years or decades), displacing an earlier technology.” Examples in asset management include index funds (Vanguard); ETFs (iShares); crowdfunding (AngelList); discount/online brokerages (Charles Schwab); and online wealth management (Wealthfront, Betterment). (See Picture 1).
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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. ”
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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.
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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.
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2. The asset management industry rarely delivers the alpha that it promises. Delivering alpha on a net of fees and costs basis consistently over many years is incredibly difficult. For example, hedge funds on average have underperformed on a net of fees basis in both US equities and bonds since 2000. Hedge fund performance looks attractive for the period of 1970 - 2013 (See Picture 2). However, one can argue that hedge funds were different in the 1980s and 1990s as the industry was smaller and more nimble. Recent hedge fund underperformance, coupled with steep typical 2% management and 20% performance fees and additional hidden costs that can be charged to fund investors, make investors more likely to ask questions.
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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.
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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.
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4. Money managers can earn more money at less personal risk than in most other industries. Simon Lack reports in The Hedge Fund Mirage that from 1998 to 2010, hedge fund managers earned $379 billion in fees, while their investors earned only $70 billion in investment gains net of fees. In the asset management industry, the norm is that the General Partner puts in just 1-2% of the total assets under management and keeps the remainder of her personal assets in a diversified portfolio. Some hedge fund managers have even set up their own sophisticated family offices specifically to diversify their holdings out of the core product in which they made their wealth. In contrast, entrepreneurs in most other fields risk a significant portion of their own capital in their new venture, better aligning incentives.
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5. The financial services industry, including asset management, has disproportionate power to create systemic economic risk. This negative externality is unique to financial services, and was particularly obvious in the 2008 financial crisis. Similarly, when the highly leveraged Long Term Capital Management fund collapsed in the late 1990s, sixteen leading financial institutions had to agree on a $3.6 billion recapitalization (bailout) under the supervision of the Federal Reserve. By comparison, when oil prices doubled between 2009 and 2011, it created stress for some industries but there was no concern that the global economy would collapse.
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6. The “broken agency” problem can cost money holders far more than the same problem does in most other industries. All companies face some form of the principal-agent problem: The chief executive of a public company may be tempted to manage financial results to optimize the short term stock price if a significant portion of her compensation comes from company stock options. In asset management, the principal-agent problem is exacerbated by the presence of so many conflicted intermediaries. For example, an individual allocator is often motivated to allocate to the most popular fund or type of investment in which her peers are investing, to protect for career risk. If an allocator hires a known player, underperformance will not cause the employee’s judgement to be questioned. The resulting herd mentality hurts innovation and leads to suboptimal returns.
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7. The investment management industry is far more homogeneous than the clients it serves, ironically for an industry that worships “diversification” as the one true free lunch. Only 10% of mutual fund AUM and 3% of hedge fund AUM are managed by women, and a similarly small percentage is managed by traditionally underrepresented minorities. This, despite the fact that funds run by women outperform. That outperformance equals the cost of money holder bias. Distributors (e.g., Registered Investment Advisors) also are disproportionately white men of middle age and older. The bias has two other main negative effects. First, it limits investors’ understanding of the world. America alone will be a majority minority country by 2040, and inevitably consumption and behavior patterns will evolve accordingly. Second, according to Carol Morley, CEO of the Imprint Group: “It is hard to attract top talent if firms are looking at a small slice of the population and their immediate peer group.”
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A Call to Action For Both Disruptors and Incumbents
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A slow growth economy has negative impact on most of the asset management industry and is forcing accountability on money managers. Many of the leading macro investors, including George Soros, Ray Dalio and Vanguard’s Chief Economist, Joe Davis, are pessimistic about global growth outlook. One of the biggest implications for asset management is that underfunded pension funds will have a difficult time meeting their return expectations. Another implication is that the large money managers that collected hefty fees from riding the long term “beta” growth wave in the 80s and 90s will have a difficult time justifying “2 and 20” fees in a lackluster economy.
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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.
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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.
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As women and millennials become key allocators, they create a new group of underserved customers with new unmet values and expectations. Womens’ $14 trillion in assets today is projected to reach $22 trillion by 2020, according to a Family Wealth Advisors Council white paper. Meanwhile, millennials are coming of age in the work force. The new decision makers will expect the industry to reflect both better gender balance and be more accessible everywhere, and will invest in money managers who do not look like Warren Buffett. Internal diversity forces an organization's members to question their assumptions more aggressively, think more deeply, and are less likely to generate bubbles, according to research by Professor Sheen Levine. Further, these two groups (women and millennials) tend to invest differently than the past generation of older men. According to the Spectrum Group, Millennials, for example, are both more risk-averse and more socially conscious than past generations when selecting investments. In addition, having come of age during the financial crisis, millennials have a negative brand perception of some of the traditionally dominant financial services companies.
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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.
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Contributors
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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”.
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Create and sustain trust through transparency. As opacity recedes, money holders will see who has been working with their best interest at heart. We foresee the doom of the black box hedge fund model. According to Amanda Tepper, CEO of Chestnut Advisory Group, “investors are increasingly demanding clear, concise and consistent communication from their asset managers. In a recent Chestnut investor survey, 92% of respondents said they view investor communication as integral to an asset manager’s mission.” In addition to investor demands, money managers must comply with an increasing array of regulatory requirements. That said, regulators have a history of protecting us from the problems of the last crisis, not the next one. As self-protection, we see increasing use of self-regulation. For example, some private investment firms will establish active executive boards similar to public companies, to give money holders and intermediaries comfort that decisions are being made thoughtfully and to create checks and balances on the historically all-powerful or cult CIO. We expect the current largely manual and sporadic due diligence process to be revamped to include more systematic, ongoing oversight and governance.
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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.”
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Disclaimers and Disclosures
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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.
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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.
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Generate new sources of alpha. The preference for alpha generation based on security selection, i.e., “stock picking”, has transitioned to alpha generation based on fund manager selection, which has transitioned to alpha generation based on asset allocation - both strategic as well as tactical. The best opportunities for alpha generation at the security and fund level, e.g., special situation or frontier markets, are shrinking over time. We envision that the ability to allocate in an agile way across multiple asset classes will be a differentiator - across both public as well as private / illiquid assets, such as private equity or real estate. We also envision more aggressive use of activist investing, broadly defined. In the world of private equity and venture capital, the equivalent of an activist strategy are those investors with a portfolio acceleration toolkit, typically including experienced operating executives and a set of preferred operational service providers.
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Geopolitical risk around the world leads to capital flight to safe havens. Political volatility is typically not good for savers and allocators as it tends to destroy asset value. Regional political instability and the fear of totalitarian regimes exists in China, Russia, the Middle East, and South America, which now have millions of well-educated and newly wealthy citizens that look to protect themselves and their nest eggs. The IMF reports that we are seeing the first net private capital outflows in emerging markets since 1984. For example, according to Bloomberg, money is quietly leaving China at the fastest pace in at least a decade: an estimated $300 billion in financial outflows in the six months through March 2015. This is double the capital ($150 billion) that exited Russia prompted by the Ukraine crisis. Overall, the economic outlook in the US is modest, but the country is relatively stable despite political dysfunction, and remains the most attractive on a relative basis. Just as immigrants streamed to Ellis Island, the wealth of the newly prosperous emerging markets will increasingly seek refuge in the United States, as well as other perceived safe havens such as Singapore and Switzerland.
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Global Investable Assets Assumptions
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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.
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Invest in talent and culture as the critical foundation.
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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.
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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., internet domain names, lifetime individual income, litigation finance, virtual currencies, cryptocurrencies, receivables, patents, frequent flyer miles, 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.
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Manage integrated risk, not risk in separate silos. The traditional view segregates risk into market, credit, and operational and buckets. For example, in the classic org chart, the Investment Officer is responsible for market risk; the Treasury Officer or CFO for counterparty risk; and the COO for operational risk. However, risk is not additive or linear, and often hot spots in one area may cause undetected issues. The money manager of the future will learn to look at risk holistically and pay attention not just to lagging indicators (losses) but to leading indicators (talent retention, investment in infrastructure, succession planning).
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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.
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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.
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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.
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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.
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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.
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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.
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Rapid technology innovation is generally positive for most money holders and will provide an opportunity to differentiate for intermediaries and money managers. Technology, and specifically the internet, will drive greater transparency, ease of use, and efficiency, while creating new opportunities for funds looking to generate alpha. But technology is neither a panacea nor fault-free, e.g., the 2015 Flash Crash and Bank of New York Mellon’s mutual fund settlement problems. Overall, technology will both raise assets and reduce fees, but it will not be a competitive differentiator on its own. Some startups will target upgrading institutions’ investing process: consider Earnest Research, which analyzes transaction data and other non-traditional data sets for investment research, and AcordIQ, a platform that institutional investors can use to gain better control and governance of funds they are invested in. Other will target individuals: Long Game is turning gamblers into investors.
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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.
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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.
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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.
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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.
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Use technology to rebalance value to investors. Internally, money managers are investing in artificial intelligence and big data capabilities and more seamless integration of front and back office processes. Externally, leaders are building mobile and tablet apps, and expanding their use of social media. In the future, innovative models, especially in the retail space, will integrate investing with elements of social media, interactive gaming and education. For institutional investors, technology will enable more proactive risk management and governance.
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Emotional Jobs to Be Done
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Functional Jobs to be Done
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Technical Jobs to be Done
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\label{section-2}
Appendix
2: The Universe of Investable
Assets
\label{appendix-2-the-universe-of-investable-assets}
To frame our analysis and understand where disruption has happened in
the past, we analyzed the global flow of assets from money holders, to
intermediaries (advisors), and on to money managers. Collectively, we
call this the universe of investable assets, which totals today roughly
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\label{section}
The
Peculiar Asset Management
Industry
\label{the-peculiar-asset-management-industry}
Asset management is a highly unusual and somewhat baffling industry. We
see seven main examples of just how peculiar our industry is, relative
to other industries:
1. The asset management industry collectively plays a
near-zero-sum
game. By contrast, most industries are positive sum: if you
eat a great steak dinner, it doesn’t imply that others have to eat
hamburger. In asset management, each new Money Manager that is able to
generate Alpha (returns above the passive benchmark performance)
normally does so at the expense of other Money Managers who
underperform. Your own investment’s value may change because of a change
in value of the underlying asset and/or market preferences. However, few
investors can impact the value of the underlying asset, except for
typically private equity and venture capital investors. And only
celebrity investors like George Soros can influence market preferences.
In fact, it is mathematically impossible for the median investor in a
given publicly-traded sector to beat a low-cost index of that sector,
after expenses. Money managers playing a positive-sum game include those
who focus on well-developed sectors for which indices are not readily
available (e.g., private companies, frontier markets) and/or nascent
asset classes
(e.g.,
names,
income,
finance,
currencies,
divorce
loans,
timber,
farms/ranches,
art,
collectibles,
or carbon
credits.
2. The asset management industry rarely delivers the alpha that
it promises. Delivering alpha on a net of fees and costs basis
consistently over many years is incredibly difficult. For example, hedge
funds on average have underperformed on a net of fees basis in both US
equities and bonds since 2000. Hedge fund performance looks attractive
for the period of 1970 - 2013 (See Picture 2). However, one can argue
that hedge funds were different in the 1980s and 1990s as the industry
was smaller and more nimble. Recent hedge fund underperformance, coupled
with steep typical 2% management and 20% performance fees and
additional hidden costs that can be charged to fund investors, make
investors more likely to ask questions.
Picture 2: Relative (Gross & Net) Hedge Fund Performance Over Time:
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\label{section-3}
The value of the universe of investable assets has increased over time,
fueled fundamentally by population growth (which typically expands the
value of the underlying corporations) and economic growth. This type of
growth is also referred to as beta return or the above-cash market
return. To benefit from such returns, investors do not require much
investment acumen other than smart diversification.
The relative size of each pool changes over time due to investor
preferences, which is driven by growth expectations, risk perceptions,
total available liquidity, and investors’ idiosyncratic views. For
example, one of the best examples of disruption is the low cost index
fund movement, pre-eminently Vanguard. As a result of the sector’s
growth, the proportion of assets managed by money managers in
traditional active core asset classes has shrunk dramatically from
nearly 60% of assets in 2003 to less than 40% today. This will likely
accelerate, as net flows into traditional active core asset classes are
negative (See Picture 7).
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3. Standard compensation models motivate Money Managers to add
more assets under management, but size often hurts returns. This
contributes to the ‘winner take all’ trend in which we see steadily
growing concentration of AUM into the largest money managers (See
Picture 3). For example, venture capital funds earn on average
two-thirds
of their compensation from management fees, not carry. However, there is
an inevitable tension between size and returns. Large hedge funds over
time hit liquidity limits and start impacting market pricing when they
trade, losing their ability to exploit arbitrage opportunities.
Similarly, large VCs earn
lower
returns than small VCs, who in turn earn
lower
returns than angel investors; angels writing small checks have among
the
highest
it is true that large size does create certain proprietary advantages,
e.g., some large fund of funds negotiate preferential management fees
from funds in which they invest.
Picture 3: US Net Cash Flows to Money Managers
The largest asset managers capture nearly all net flows into the US
market; net flows to other managers are down significantly.
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4. Money managers can earn more money at less personal risk than
in most other industries. Simon Lack reports in
The
Hedge Fund Mirage that from 1998 to 2010, hedge fund managers earned
investment gains net of fees. In the asset management industry, the norm
is that the General Partner puts in just 1-2% of the total assets under
management and keeps the remainder of her personal assets in a
diversified portfolio. Some hedge fund managers have even
set
up their own sophisticated family offices specifically to diversify
their holdings out of the core product in which they made their wealth.
In contrast, entrepreneurs in most other fields risk a significant
portion of their
own
capital in their new venture, better aligning incentives.
5. The financial services industry, including asset management,
has disproportionate power to create systemic economic risk. This
negative externality is unique to financial services, and was
particularly obvious in the 2008 financial crisis. Similarly, when the
highly leveraged Long Term Capital Management fund collapsed in the late
1990s, sixteen leading financial institutions had to agree on a $3.6
billion recapitalization (bailout) under the supervision of the Federal
Reserve. By comparison, when oil prices doubled between 2009 and 2011,
it created stress for some industries but there was no concern that the
global economy would collapse.
6. The
“ broken
agency” problem can cost money holders far more than the same
problem does in most other industries. All companies face some form of
the principal-agent problem: The chief executive of a public company may
be tempted to manage financial results to optimize the short term stock
price if a significant portion of her compensation comes from company
stock options. In asset management, the principal-agent problem is
exacerbated by the presence of so many conflicted intermediaries. For
example, an individual allocator is often motivated to allocate to the
most popular fund or type of investment in which her peers are
investing, to protect for career risk. If an allocator hires a known
player, underperformance will not cause the employee’s judgement to be
questioned. The resulting
herd
mentality hurts innovation and leads to suboptimal returns.
7. The investment management industry is far more
homogeneous
than the clients it serves, ironically for an industry that
worships “diversification” as the one true free lunch.
Only
10% of mutual fund AUM and 3% of hedge fund AUM are managed by women,
and a similarly small percentage is managed by traditionally
underrepresented minorities. This, despite the fact that funds run by
women
outperform.
That outperformance equals the cost of money holder
bias.
Distributors (e.g., Registered Investment Advisors) also are
disproportionately white men of middle age and older. The bias has two
other main negative effects. First, it limits investors’ understanding
of the world. America alone will be a majority minority country by 2040,
and inevitably consumption and behavior patterns will evolve
accordingly. Second, according to Carol Morley, CEO of the
Imprint
Group:
“It
is hard to attract top talent if firms are looking at a small slice of
the population and their immediate peer group.”
The
Macro Trends Forcing Change on Our Industry
\label{the-macro-trends-forcing-change-on-our-industry}
Global tectonic shifts - technology revolution, globalization, the
increased role of women and millennials and a generational turnover
among chief investment officers - are an irresistible force meeting a
moveable object: the traditional asset management industry structure.
(See Picture 4 for a summary.) Meanwhile, asset management shows the
traditional earmarks of an industry ripe for disruption — most
obviously, unhappy customers and very profitable incumbents.
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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
\label{terminology}
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About the Authors
Katina Stefanova (Stamford, CT) is CIO and CEO of Marto
Capital, a systematic multi strategy asset manager. From 2005 to 2014,
she served as a Senior Executive and Management Committee Advisor at
Bridgewater Associates during the company’s rapid expansion into the
largest and one of the top performing money managers in the financial
industry. To date, Bridgewater has added more value in absolute terms to
its investors than any other investment firm. Katina held both
investment and senior management roles reporting directly to the CEO.
During her tenure, Bridgewater grew from $15 billion to $150 billion
assets under management and from 200 to 1400 employees. Contact:
[email protected]
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Global Investable Assets Assumptions
To estimate global Investable Assets, we made the following assumptions:
-
Defined the universe of Investable Assets (See Terminology) as all
financial capital available for investment in the world economy, less
operating capital, i.e., less the resources the world economy needs to
function on an ongoing basis.
-
Defined Money Holders as the original owners of the Investable Assets,
who have the most to gain or lose from the appreciation or
depreciation of the investment.
-
Ignore in this definition
government-owned
commercial assets, which amount to approximately $75 trillion in
value, and are a largely opaque asset class not fully driven by market
forces.
-
Included real estate and specifically the purchase of primary homes,
which can technically be both considered working capital or
investment. Owning a house is not only a operating need, but also a
form of investment and a store of wealth for the majority of Money
Holders, especially those with less than $1 million in net worth.
-
Categorized insurance and pensions as Money Holders, although the
policies belong to individuals and they are in fact a hybrid group
that can be considered also part of Intermediaries.
-
Excluded leverage as part of asset manager AUM, although leverage acts
like an accelerator that increased return at higher volatility. For a
comprehensive study of the impact of leverage, which currently stands
at the formidable number of $200 trillion, we recommend reading
Global
Debt and (Not Much) Deleveraging, from McKinsey & Co.
Disclaimers and
Disclosures
\label{disclaimers-and-disclosures}
The opinions expressed herein are only those of the authors
individually, and do not represent the views of any of their employers
or of any other institution with which they are affiliated.
Katina Stefanova is an investor in
AcordIQ
and Long
Game; is a former
Bridgewater
Senior Executive; and continues to have financial interests in
Bridgewater.
David Teten has a financial interest in
Addepar,
Earnest
Research, and
Indiegogo.
Brent Beardsley has been a consultant in the past and possibly in the
future to some of the leading global financial services institutions
mentioned above.
Contributors
\label{contributors}
This study would not have been possible without the collaboration and
support from The
Boston
Consulting Group. We also want to thank the research, technology and
editorial team who supported us during this study: Greg Durst, Jen
McPhillips, Jenny Wong, Charles McLaughlin, Michael Rose, and James
Ebert.
We give special thanks to the dozens of industry leaders that
contributed to this study with their insight. All errors herein are our
responsibility. Among those we interviewed:
Dr Rania Azmi, International Investment Expert & Speaker
Tom Bartman, Senior Researcher, Forum for Growth and Innovation, HBS
Omar Bassal, Head of Asset Management, Mohammed Alsubeaei & Sons
Investments Company
John Casey, Chairman of CaseyQuirk
Mary Cahill, CIO of Emory
Charles Dooley, CEO of AcordIQ
Greg Durst, COO of Marto Capital, former Endeavour, CEO of Africa
Grant Easterbrook, Co-founder, Dream Forward Financial
Charles “Charley” D. Ellis, Founder, Greenwich Associates
Scott Evens, CIO of New York Pension System
Steven Fradkin, President, Wealth Management, Northern Trust
Jeff Hunter, CEO and Founder of Talentism
Omar Kodmani, CEO of Permal
Charles McLaughlin,
Principal,
National Security Practice,
Censeo
Consulting Group
Gary Markovitz, CEO of Business Innovation Partners
Carol Morely, CEO of the Imprint Group
Joseph W. Reilly Jr., family office consultant
Peter Sanchez, CEO Northern Trust Hedge Fund Services
Harry Singh, CFO at AIG Operations
Dhivya Suryadevara, CIO of GM Pension Fund
Amanda Tepper, Chestnut Advisory Group
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Invest in talent and culture as the critical foundation.
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Picture 10: Defined Terms
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Table of Contents
The Peculiar Asset Management Industry
The
Macro Trends Forcing Change on Our Industry
The
Money Manager of the Future
The
Jobs To Be Done in Asset Management
Terminology
Disclaimers
and Disclosures
Appendix
1: Full List of The Jobs to Be Done in Asset Management
Technical
Jobs to be Done
Functional
Jobs to be Done
Emotional
Jobs to Be Done
Appendix
2: The Universe of Investable Assets
Contributors
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Use technology to rebalance value to investors. Internally,
money managers are investing in artificial intelligence and big data
capabilities and more seamless integration of front and back office
processes. Externally, leaders are building mobile and tablet apps, and
expanding their use of
social
media. In the future, innovative models, especially in the retail
space, will integrate investing with elements of social media,
interactive gaming and education. For institutional investors,
technology will enable more proactive risk management and governance.
Create and sustain trust through transparency. As opacity
recedes, money holders will see who has been working with their best
interest at heart. We foresee the doom of the
black
box hedge fund model.
According
to Amanda Tepper, CEO of
Chestnut
Advisory Group, “investors are increasingly demanding clear, concise
and consistent communication from their asset managers. In a recent
Chestnut investor survey, 92% of respondents said they view investor
communication as integral to an asset manager’s mission.” In addition
to investor demands, money managers must comply with an increasing array
of regulatory requirements. That said, regulators have a history of
protecting us from the problems of the last crisis, not the next one. As
self-protection, we see increasing use of
self-regulation.
For example, some private investment firms will establish active
executive boards similar to public companies, to give money holders and
intermediaries comfort that decisions are being made thoughtfully and to
create checks and balances on the historically all-powerful or cult CIO.
We expect the current largely manual and sporadic due diligence process
to be revamped to include more systematic, ongoing oversight and
governance.
Manage integrated risk, not risk in separate silos.
The
traditional view segregates risk into market, credit, and operational
and buckets. For example, in the classic org chart, the Investment
Officer is responsible for market risk; the Treasury Officer or CFO for
counterparty risk; and the COO for operational risk. However, risk is
not additive or linear, and often hot spots in one area may cause
undetected issues. The money manager of the future will learn to look at
risk holistically and pay attention not just to lagging indicators
(losses) but to leading indicators (talent retention, investment in
infrastructure, succession planning).
Generate new sources of alpha. The preference for alpha
generation based on security selection, i.e., “stock picking”, has
transitioned to alpha generation based on fund manager selection, which
has transitioned to alpha generation based on asset allocation - both
strategic as well as tactical. The best opportunities for alpha
generation at the security and fund level, e.g., special situation or
frontier markets, are shrinking over time. We envision that the ability
to allocate in an agile way across multiple asset classes will be a
differentiator - across both public as well as private / illiquid
assets, such as private equity or real estate. We also envision more
aggressive use of activist investing, broadly defined. In the world of
private equity and venture capital, the equivalent of an activist
strategy are those investors with a
portfolio
including experienced operating executives and a set of preferred
operational service providers.
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How to Who Will Disrupt the Investing Industry
Asset Management, and How
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- Categorized insurance and pensions as Money Holders, although the policies belong to individuals and they are in fact a hybrid group that can be considered also part of Intermediaries.
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- Defined Money Holders as the original owners of the Investable Assets, who have the most to gain or lose from the appreciation or depreciation of the investment.
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- Defined the universe of Investable Assets (See Terminology) as all financial capital available for investment in the world economy, less operating capital, i.e., less the resources the world economy needs to function on an ongoing basis.
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- Excluded leverage as part of asset manager AUM, although leverage acts like an accelerator that increased return at higher volatility. For a comprehensive study of the impact of leverage, which currently stands at the formidable number of $200 trillion, we recommend reading Global Debt and (Not Much) Deleveraging, from McKinsey & Co.
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- Ignore in this definition government-owned commercial assets, which amount to approximately $75 trillion in value, and are a largely opaque asset class not fully driven by market forces.
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- Included real estate and specifically the purchase of primary homes, which can technically be both considered working capital or investment. Owning a house is not only a operating need, but also a form of investment and a store of wealth for the majority of Money Holders, especially those with less than $1 million in net worth.
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- Customer service is critical for both retail and institutional investors.
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- Helping savers apply self discipline is also a simple but effective way to add differentiation. Just as with losing weight, there is no shortcut to amassing investable assets. 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.
- Thematic investing takes the guesswork out of the equation: Traditional investment consultants offer very granular tools to diversify along the investment spectrum. Today, 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. for example, Himalaya Capital offers access to Chinese Equities. Shehzad Janab’s Daman Investments hedge fund provides access to the UAE market. These targeted opportunities can, at times, outperform developed markets. However, investors should be prepared to accept local economic risk, political risk, low liquidity and well as lack of diversification within the themes.
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- Investors increasingly desire to put their money where their heart is - whether it is based on social consciousness, religious views or a hobby: 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. Religious institutions (e.g., the Catholic Church and Mormon Church) and religious individuals/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. At the hobby end of the spectrum, some investors buy Berkshire Hathaway stock just to get an invitation to their annual meeting. This is also true of those who put money into art, wine, jewelry, antiques, stamps, or even a sports team. These investments are often more for personal utility than financial investments. We see empty nester Baby Boomers in the West and nouveau riche in Russia and China driving up the value of these “passion investments.”
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- Investors want transparency into what is actually happening with their money. As the Millennials begin to invest their own funds or become CIOs at asset allocators, they will expect the same “at your fingertips” accessibility to their portfolio that they now have from their Facebook account. Some money managers are beginning to adjust: 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 trading sauce with its clients.
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- Money holders want to learn how to be better investors: The under-resourced and often “relatively” underpaid institutional investor, the family office, and the smaller retail investor all find it difficult to keep current with market trends. They may have little understanding of the arms race around esoteric asset packaging rampant on Wall Street, or how high frequency trading actually affects the market. It falls to money managers to educate investors on how new strategies work, although potential conflicts of interest abound. The fastest growing sector in investment research for the last two decades are expert networks, e.g., GLG. These networks displace what some managers considered their investment edge – a proprietary group of expert relationships built up over years in the business. The expert networks offer direct access to experts on any possible category for on-the-fly education. Northern Trust’s private wealth practice has built an analytical platform that educates high net worth individuals about designing customizable portfolios specific to their unique circumstances. Both these companies are strengthening the decision-making capabilities of their clients.
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- Pension funds and endowments struggle to match liabilities and obligations. Institutional investors, in particular, 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. This functional need is dominating internal conversations at investors that are working to meet long term obligations. Bond funds, a traditional source of cash flows for asset & liability matching, clearly struggle to offer critical returns in low or near-zero interest rate environments. Alternatively, commercial and multi-family real estate funds, which provide a blend of annual dividend-like payments and opportunity for appreciation at exit, have also become a popular investment for liability matching.
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- Political and “public good” goals rank high on the agenda of government-owned money managers. Special interests, preservation of power, and economic development goals can all be part of government investor agendas at city, state and federal levels. Such investors may have defined public service goals, e.g., invest in companies in their home state or support minority owned businesses. Similarly, sovereign funds in the Middle East look for ways to invest locally in industries that decrease their dependence on the energy sector. Yet, we see few money managers that specifically target the unique needs of these public or quasi-public managers on these dimensions.
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- Retail investors increasingly care about how much money they take home, not the gross return - before taxes & fees - reported on their investment statement. Poorly managed taxes and transaction costs can kill investment returns. As protection, robo-advisors provide automatic tax loss harvesting to help investors minimize taxes. Some specific investment instruments also aim to minimize taxes, e.g., life insurance for inheritance planning and municipal bonds are tax-advantaged products. An emerging manager, Greenline Partners, offers a risk parity model not common among money managers serving institutions. The Greenline solution focuses on tax minimization by understanding the long term impact of deferring taxes and overlaid with a unique tax loss harvesting methodology.
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Double-click this text to start writing.