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Yes, asset management—and particularly institutional asset management—is evolving. But it was ever thus. Perhaps the better question is “why”? Is asset management transforming itself for a reason that is inherently game-changing?
Institutional investors come in profoundly different shapes and sizes, but commonalities have become clear in these last five years. Only a relatively small group of asset owners have the intellectual capital to navigate an interconnected investment world; the recognition of that is itself a sea change. It is the prime—although far from the sole—driver of investment outsourcing. And the important aspect of investment outsourcing that needs to be understood is that it is not another tactical evolution. It is a game-changer, indeed the future of asset management: Any asset manager that wants a direct relationship with its institutional customers is going to have to come to the table with many of the attributes that now seem to be the property of specialist investment outsourcers. It’s that simple, like it or not.
Most asset managers have not and cannot come to terms with this. It forces them to contemplate elevated levels of capabilities and client service that are unthinkable. It also obliges them to embrace open architecture. These managers who eschew the logic of outsourcing, or at least those of them that are good at investing (never a given in an industry that has allowed mediocrity to thrive), are going to have different and more demanding customers: the outsourcers.
This is not some cosmetic change. This is a fundamental re-shaper of the industry. If your “clients” suddenly become investment outsourcers, investment platforms, and open-architecture target-date providers, you’re not in the same business you were in just a few years ago. Customization, not scalability, is the new watchword. Oh yes, and good luck with your fee negotiations.
Good luck, too, with your long-only equity strategies. Institutional investors in the main want equity beta. Where they will reach for alpha is via products and managers that have demonstrated track records in specific alternative asset classes, and in more explainable and transparent exchange-traded fund-based solutions. Risk in its more naked form—and what is more naked than a long-only equity manager who claims to be able to consistently uncover value in a transparent and irrational equity market—no longer holds a whit of appeal.
For the best (and, admittedly, only the best) fixed-income managers, there is a more interesting reality. The thinking that liability-driven investing (LDI)-obsessed corporate defined benefit (DB) plans are somehow going to have a road-to-Damascus moment because rates rise and immunization proves a goal rather than a reality is delusional. Corporate DB plans will pursue LDI, or the next iteration of LDI, until the last liability is either paid out or annuitized. End of story.
As for public funds, it is facile to dismiss the arena as a backwater. It will prove more resistant to the logic of outsourcing because there is an incentive for the decision-makers to keep their hands on the controls; and, because the liabilities continue to accrue, risk-reduction alone cannot drive their investment strategies. But change is afoot. Better and increasingly well-considered alternative strategies are being pursued. Different fee and vehicle structures are being forced on hedge funds and private equity firms-and it’s about time.
Sovereign wealth funds will also be a force for change, primarily as they come to terms with their buying power. They will be looking for better risk-sharing with asset managers. This should be a constant theme of this next decade: Highly sophisticated investors will seek the sort of direct interaction with investment opportunities, particularly in private equity and real estate, which has long been the sole province of asset managers. Just as two decades ago firms like BlackRock began to demonstrate that the information edge did not inevitably belong to Wall Street, we can anticipate that the largest and most sophisticated asset owners going forward will operate on a much more level playing field when it comes to information and access.
Part of leveling that playing field will be a new accent on fee diminution. Beta has been cheap for some time: It will get cheaper still. Investors will pay slightly more for smart beta. Some premium pricing will survive: A handful of hedge funds will, for the time being, thrive on scarcity value, at least until their performance stumbles. But beyond those happy few, fees will begin to reflect a harder reality. Once upon a time, alternative fund-of-funds offered reasonable value—when hedge funds were hard to identify and harder to monitor—but those days are long gone. Now we all know about Bridgewater and Two Sigma and their peers, and a great risk management system is a phone call (and a check) away at MSCI. There is simply no need any longer to pay an Idiot Tax.
If this all sounds vaguely depressing, it should strike exactly the opposite chord. The asset management industry is American ingenuity at its most acute, and it is reinventing itself just in time. More to the point, it is reinventing itself to better service its institutional clients, who are waking up these days to very different realities. Perhaps the most important lesson we can learn from the inimitable Bernie Madoff is not that crooks can get away with it for decades, but rather that the investment savant, like the mayfly, is a creature of distinct impermanence.
The fact is, there are no little gods in today’s investment world: The complexities and interconnections will simply confound even the brightest. The best investors today know one big thing (Warren Buffet, for example) or are continually questioning everything they think they know (Ray Dalio): either way they are fallible, and will happily acknowledge the fact. “Infallible” investors are either lucky (and luck ends, often drastically) or self-delusional. Great investment managers are not the witchdoctors of yore, and any information edge anyone has today is very much on the margin.
Asset owners should look for patience, process, transparency, an obsession with detail, and reasonable fees from their investment management partners. They should look for managers that seek out returns with one eye on the nature of the liability their clients face and with the other eye on the nature of the risks they are taking. The best institutional managers will do exactly that, and will be rewarded for so doing. Many will not meet that standard, as it is a much higher hurdle than the traditional benchmark-beating (or, as often as not, benchmark-hugging) standard to which managers have been held for many decades. Those that cannot breast these new benchmarks will fade away or self-destruct. That’s a good thing, and, again, it was ever thus.