Column: Thou Shalt Not Pass

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I have written in these pages before about the very different asset management skills that are going to be required by the asset owners of tomorrow. This column is less about asset management and more about all the other providers interested in feeding at the great institutional trough.

First, Wall Street. Almost without exception, Wall Street firms have proven persistently hapless in their courting of American asset owners. Their asset management efforts have flattered only to deceive—as a prime example, a parade of exceptionally talented asset managers have passed through the revolving doors of Goldman Sachs Asset Management over the years and have rarely found occasion to stay. JP Morgan’s asset management business is perhaps the exception, but then JP Morgan was not an investment bank until, suddenly, it was. The fact is that investment banks never could come to terms with asset management, even when they bought good firms.

When it comes to offering other services to asset owners, investment banks have never distinguished themselves. At transition management, they were perceived to be more interested in their own welfare than that of their clients—likewise in securities lending, prime brokerage, and indeed anything they touched in the asset-owner community. It takes a long spoon to sup with the Street, and most plan sponsors didn’t and don’t have the appetite for it.

In recent months, Morgan Stanley appears to have found a role to play as an advisor to some of corporate America’s blue chip funds as they navigate the path toward pension risk transfer. It is a growing trend, and hats off to Morgan Stanley for devoting the resources that that process demands. It will be interesting to see whether they retain that primacy. If history is our guide, they will in time find a way to lose their way.

The handful of custody banks that dominate the institutional space are challenged at the present time. Asset owners have come to take custody for granted, and it is bred into their bones that they can essentially get this service for next to nothing. The irony is that global custody is far from free—it is in fact expensive to provide. But State Street, BNY Mellon, JP Morgan, and Northern Trust all allowed their fees to fall and instead looked to take up the slack, and more, in related services like foreign exchange, securities lending, and transition management. That music has now stopped: for a variety of reasons, all of these businesses are under pressure.

These factors, amplified by an unforgiving interest rate environment and escalating regulatory costs, are vexing to global custodians. And yet this should be an interesting decade for the better-run players. Custody remains an oligarchy, with immense barriers to entry: pricing power, while absent in fact, certainly exists in theory, and will surely reassert itself in time. Niches where independent providers thrived—like hedge fund administrators—are being absorbed into the Borg. The wealth of information and services that reside in these custody banks is substantial. The trick is monetizing it. It is written here that the best of these institutions will thrive in this decade—they will get paid differently, to be sure, but they remain an indispensable link in the chain. Money managers will come and go—custodians are eternal.

Consultants, too, are eternal, but their future is less easy to predict. Is there room for boutiques when the likes of Mercer and Aon Hewitt can bring so much to the table? Can consultants survive the trend to outsourcing, or can they co-opt it? If I were trying to sell a consulting firm—if I was Dennis Tito, for example—I would have sold it this year. A handful of consultants will survive and thrive, to be sure, but the secular trends are alarming.

Insurance companies long ago lost their relevance to asset owners. Now, astonishingly, they are relevant again. Prudential is now king of the hill in pension risk transfer, and it and others are likely to dominate the retirement income product set inexorably making its way into the next generation of defined contribution offerings. This won’t be a golden age for insurance companies—they remain mired in bureaucratic molasses—but their attributes are coming into their own. Astonishingly enough, slow and steady sometimes wins the race.

All in all, a time of flux lies ahead of us in the institutional space. The market might indeed be efficient, but not all of the players are. Asset owners have plenty of hard decisions to make as to which to trust with their funds.

Charlie Ruffel, the founder of aiCIO and Asset International’s other media brands, is a global authority on retirement, asset management, alternative investments, and securities services issues. He is now Managing Partner at Kudu Advisors, which provides M&A and strategic advisory services to institutional asset management and global asset servicing businesses.