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Ripe For Disruption: The Asset Management Business

FWRJoe Reilly, CEO of Circulus Group and a longtime contributor to Family Wealth Report, interviewed me to share views on disruption in asset management, my research into the field, and where the industry needs to be headed.

Reilly: You’ve been co-leading a research project on innovation in the investment management industry, which became an Institutional Investor cover story: “Asset Managers, Prepare to Have Your Business Disrupted”. Readers can see a video and slide deck summary of your work here. What prompted you to explore this space?

Teten: Two reasons. First, I am an investor in a range of companies that are in, or serve, family offices and other large investors (e.g., Addepar,  AsaakClarity (sold to Goldman Sachs), Earnest Research, Indiegogo, Republic.co, Stratifi). I knew that executing this research, and then publishing it, would attract pertinent investment opportunities. 

And second, I wanted to inform the strategy of my new firm, Versatile VC, from the most educated point of view. 

Reilly: In your research, you use the Clay Christensen framework of “jobs to be done”. Can you explain that?

Teten: Professor Clayton 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 generating alpha, 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.” 

Disruption theory identifies companies which serve one job particularly well as the most likely source of radical, disruptive growth. So I mapped out in my research the companies that are focusing on just one job for family offices.  They often do a terrible job on everything else that an investor may seek.

The paradigmatic example for me is Vanguard. They do one job: deliver average returns at a low price, and they do it really well. When they launched, people mocked them, but they’ve been tremendously successful and of course disruptive to the established players.

Reilly: Who is your research geared to?

Teten: In the Before Time, I was at a dinner for Partners at many of the major New York VC funds. One Partner said, “So, what do you all think of AngelList?”  Another said, “I think it’s remnant inventory…the Craigslist of venture capital. I don’t think it’s a threat to established VCs.” But a third Partner said, “Isn’t that sort of like Hyatt dismissing AirBnB as a threat they don’t need to take seriously?”

In hindsight, the third Partner was right.  

So with that preamble, I think that anyone working at an established asset management firm should understand the threats to their established profit streams. Jamie Dimon, CEO of JP Morgan, wrote, “There are hundreds of startups with a lot of brains and money working on various alternatives to traditional banking [and asset management]”…. “They all want to eat our lunch…Every single one of them is going to try.”

In addition, I think that fintech entrepreneurs seeking market white space should be working to understand how to take advantage of the market opportunity gaping in front of them.

Lastly, of course, any family office should understand the creative, focused, new service providers which may be helpful to them.

Reilly: You have described the asset management industry as “somewhat baffling.”  Why is that?

Teten: Asset management is a highly unusual industry. Two examples of 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 in the liquid markets that is able to generate alpha 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., crypto, at least to date).
  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. How many other industries collectively fail so consistently to do what they are paid to do? 

Reilly: What macro trends are forcing change on the investment management industry?

Teten: Among others, geopolitical risk globally is leading to capital flight to safe havens. This is true in the US too, not just in places like Hong Kong. Yale School of Management’s Jeffrey Sonnenfeld recently observed that business leaders may tilt Democratic or Republican, but they all agree that if the losers of an election do not accept the results, that’s bad for both society and their respective businesses. 

Investors are much more aware now of new categories of risk. Most recently, COVID-19 taught the world to take the pandemic risk seriously. It is a safe bet that we will see other tail risk events over the next decade: extreme climate events, large scale takedowns of the critical internet infrastructure, electromagnetic pulse attacks, and who knows what else. We have to worry about both “black swans” (unforeseeable risks) and “grey rhinos” (foreseeable risks).

From my point of view as a VC, what gives me comfort is whatever crazy things happen in the world, it’s a safe bet that technology will continue to be more and more important.

Reilly: What do you find is most disruptive in the industry right now?  What do you see changing over the next five years?

Teten:  I will offer my two highest-confidence predictions: 

1) Private equity and venture capital investors are going to copy our sisters in the hedge fund world by automating more of our job. When I was single, I registered for (a lot of) dating websites. When I met my now-wife, I realized that any technology that can find me a spouse is a killer app. That’s why 40 million Americans use online dating sites. But, most funds raise capital and source deals the same way people looked for dates 20 years ago: by networking at conferences (or bars). Venture capitalists are now eating our own dog food, by using technology and analytics to make better investments.

2) The asset management industry will become more diverse, both because many of the current owners of asset management businesses are due to retire in the next decade, and because the money holder class (the clients) are far more diverse than the money managers who want to work for the money holders. 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 transition out of his hedge fund lead to huge simultaneous redemptions, followed by fire sales, and eventually the closure of a highly successful $8 billion hedge fund. Meanwhile, 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 is inconsistent with the fact that women control $14 trillion in assets today, projected to reach $22 trillion by 2020, according to a Family Wealth Advisors Council white paper. 

Reilly: You’re an investor in a number of companies which are intermediating between family offices and investment opportunities, e.g., Indiegogo and Republic.co. How can these direct investing platforms attract family offices and other large investors?

Teten: The table stakes for all these companies are to execute on the ‘jobs to be done’ that any competent direct-investing platform must provide, as compared with the option of investing in a fund: control; administration; data about the deals; compliance; and of course the traditional benefits of alternatives (low correlation, illiquidity premium, etc.) However, I’ve identified a range of other levers that platforms can use to attract more family offices and other large investors. 

We don’t have room to discuss here, but see How do you attract family offices and other large investors to your direct investing platform?

Reilly: A lot of family offices are interested in investing directly into companies, but don’t want to lead rounds. So how can they get invited into rounds?

Teten: In order of descending impact:

  1. Invest in a fund, and tell them you want as many direct opportunities as possible
  2. Publicize that you’re value-added in a specific industry, and build relationships with all the VCs in that industry
  3. Publicize that you’ll quickly coinvest in rounds led by reputable VCs

Joining syndicates is a hard strategy to execute well without suffering the “winner’s curse”, because the VC industry has so many followers (price-takers) and so few price-setters. For more on this from a VC point of view, see How VCs structure a syndicate and recruit coinvestors

Reilly: Right now, you have the great luxury of starting a new business from a blank slate, in the way that you think makes the most sense. What is Versatile VC’s strategy?

Teten: We’re doing three things that are unusual.

First, Versatile Venture Capital invests in capital-efficient companies. Of the Inc. 5000 companies, only 6.5% raised money from VCs and 7.7% raised from angels. And of that tiny number, less than 0.1% drive the bulk of returns for the VC industry. Yet, scalable technology and tools are finding their way into new and old businesses at an unprecedented rate. 

That’s crazy, given how much effort the entire VC industry puts into identifying growth companies. We are venture capital for the other 93%. We have the flexibility to invest using both traditional and alternative VC structures.

Second, Versatile is launching Founders’ Next Move, an invite-only, no-cost community for founders researching their next move. Typically, they’re considering launching a new company; getting a job; angel investing; consulting; and education/self-improvement. I suspect many of your readers would get value from our free career resources.

Third, we are an aggressive user of technology internally, both to manage the firm and make better investments. 

Reilly: A lot of our readers organize events regularly for family offices. You did the same thing given your role as Founder of Harvard Business School Alumni Angels of Greater New York, the largest angel network on the East Coast. What are the best ways to attract investors to events?

Teten: My top 6 recommendations: 

  1. Advertise that the event is strictly gated to family offices, and detail how you curate.
  2. Get a lead sponsor which is a single family office. 
  3. Offer unusual experiences or speakers. Money can buy almost any product, but not any experience.
  4. Design the event to be health-conscious. See How to Keep Your Conference Attendees Alive.
  5. Discuss sensitive topics not readily obtainable via Google.
  6. Moderate aggressively.

 For more ideas, see 11 Ideas to Organize an Event Family Offices Want to Attend.

Reilly:  The innovation buzz du jour is around crypto, and at the moment notably Lightning. Do you consider these developments disruptive?

Teten: Fundamentally, I’m not an investor in blockchain-based companies per se. Rather, I’m happy to be an investor in a company which leverages blockchain technology because blockchain technology is the optimal way to solve a problem for a market. As opposed to, because words like “blockchain” and “crypto” tend to get some investors very excited. 

I’ll give you three examples from HOF Capital’s portfolio of real-world use cases of crypto:

  • Braintrust enables people to access talented freelancers without middlemen or markups. Their innovative model is uniquely enabled by blockchain technology and the BTRUST token.
  • Terra is programmable money for the internet. Terra’s “Anchor Protocol” allows Terra stablecoin deposits to earn stable yield, powered by block rewards of leading proof-of-stake blockchains. Their original primary use was making it easier to purchase on ecommerce websites in East Asia, which is historically very difficult.
  • Republic allows investors to access highly-vetted investment opportunities in startups, real estate, video games, and crypto. Republic has developed the Token Purchase Agreement, which is not equity, debt, or a token itself, but a contract that entitles you to tokens in the future. Republic has also developed the Republic Note, their own digital security, a profit-sharing token with finite supply. This distributes dividends when select Republic portfolio companies succeed. These are both creative ways of solving real problems for real-world clients.

Reilly: Thanks so much for sharing your learnings with us!

 

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