The investment industry is one of constant change. New ideas are quickly assessed and absorbed, reflecting the highly competitive nature of the market structure. Proprietary intellectual property is hard to identify and capture so that developments and improvements in thinking tend to be quickly assimilated into general market thinking.
As a result, companies in the industry are likely to focus on a few areas in which to profit, but these can be whittled down to two distinct categories: specialist portfolio construction skills or volume. The former reflects the usual ‘special sauce’ sales pitches of investment managers showing why their style or research is ‘market beating.’ The latter is a result of the commoditization of investment through indexation, allowing vast quantities of monies to be invested extremely cheaply.
What is interesting about these categories is the lack of strategic advice, even though most industry participants would agree that investment strategy is the most important issue any asset owner faces. This is perhaps a significant reason why large asset owners have opted to build in-house teams of some fashion. In doing so, these asset owners can focus on the strategic decisions, align the methods and modes of investment, and increase transparency of costs. The most important thing an asset owner can do, though, is to customize its strategic decision processes for itself.
This betrays one of paradoxes of the investment industry. Strategic decisions and advice are extremely important but highly specific to the circumstances of each asset owner. They also tend to have complex implications, with significant impact across the asset owner’s business and on its objectives. This makes general approaches to investment strategy of little value to asset owners.
On the other hand, investment implementation is able to be commoditized and is more profitable for investment managers. These decisions are easier to identify and understand. It is of no surprise, then, that this is where most of the resources of the industry are focused—but it reinforces the point that the investment industry is not geared towards the interests of asset owners.
Where does this leave the intermediaries of the industry—the consultants that typically occupy the space between asset owners and asset managers? First, it should be acknowledged that asset consultants are not responsible for the legal and regulatory environment within which they work. Any fault of the industry structure has to lie with the regulators—and large volumes have been written already on the problems with the investment industry’s market structure.
What is useful to observe is the asset consultant reaction to market developments in the context of the industry structure. A significant development is the growth of fiduciary management and outsourced-chief investment officer services. Do these developments help resolve the paradox identified above?
Unfortunately for asset owners and the industry at large, the answer is no. Both of these developments are skewed to the portfolio construction or volume considerations noted above. From the perspective of running a business, this makes sense: there are no economies of scale in offering specific strategic advice to each individual customer. This is why each asset owner has to take responsibility themselves for these issues. It is why no asset consultant—or asset manager—has been able to take on the identity of the truly trusted advisor.
Yet trusted advisors are what the industry most needs. Trusted advisors are one of the ways in which asset owners can bring in specialized knowledge to assist in understanding what strategic choices they face, what the alternatives are for those choices, and how to make them. At a bare minimum, each asset owner has to build the internal resources to achieve these outcomes—and if it does not have the resources to do so, ensure it has an impartial advisor it can rely on.
Asset owners should always be asking and addressing two questions: 1) How can I ensure that I can understand and deliver answers to the strategic challenges with impartial in-house resources?; and 2) How can I use trusted, impartial advisors to assist this? The current industry structure does not fully confront this problem.
Stefan Dunatov is CIO of Coal Pension Trustees, a member of the investment committee at the Wellcome Trust, and chair of the 300 Club.