Power in the investment management industry is shifting to Money Holders from Money Managers, driven by several major economic, social, and political trends. Collectively, these are an irresistible force meeting a moveable object: the traditional asset management industry structure. We highlight below five key trends impacting our industry:
1. As women and millennials become key allocators, they create a new group of underserved customers with new unmet values and expectations. By 2030, women are expected to control $19.1 trillion in assets, and millennials $12.0 trillion, according to CNBC and Deloitte respectively. The new decision-makers will expect the industry to reflect both better gender balance and be more accessible. Women and millennials tend to invest differently than the past generation of older men. According to the Spectrum Group, millennials are both more risk-averse and more socially conscious than past generations when selecting investments, e.g., they pay attention to the diversity level of corporate boards and to their climate impact. 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. The change in the values of the investor base helps explains the rise of the popularity of ESG investing.
Additionally, allocators are becoming a lot less tolerant and unwilling to turn a blind eye towards toxic cultures of sexual harassment and discrimination, which have for years been tolerated at some largely male-led investment managers. For example, the Wall Street Journal has written multiple articles about concerns of sexual harassment and discrimination at Bridgewater Associates. The question remains: will allocators begin to vote against such behavior with their investment dollars? Our view is that as the culture and preferences of allocators change, so will their investment criteria and the tolerance for bad behavior. In addition, internal diversity in an investment organization 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.
Suzanne Ley, formerly Head of Financial Institutions, Westpac, observes that millennials are, “inherently distrustful of authority so the traditional financial adviser model is not going to work for them; demand complete transparency in all aspects of their life so hidden/opaque fees structures are not going to be tolerated; and have a high propensity to move jobs more frequently than past generations, so the portability of financial assets is going to be very important going forward.”
2. 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. We have now entered a new cold war, this time between the US and its new counterpart China. This war is ideological in part, but it is also in large part about technology dominance and cybersecurity. It is therefore no surprise that the US and Europe are imposing drastic sanctions on Chinese companies, and vice vera. The goal of these sanctions is not to protect market share but to protect access and information in an era where social media companies (TikTok) and infrastructure providers (Huawei) have massive strategic importance. This is not a war that the US and the European Union can afford to lose.
The new cold war has only increased the flight of capital from regions of instability to regions of relative stability. The fear of totalitarian regimes or anarchy 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. We are seeing the first net private capital outflows in emerging markets since 1984. Even though the economic outlook in the US is negative and the Covid-19 response inadequate, the country remains relatively stable. Together with places like Switzerland, Singapore, and the UK, the US remains among the most attractive as a safe haven.
The greatest opportunity for growth we see for pension funds and wealth management funds is geographical. While traditional markets in Europe, the US, and Japan are saturated, India, for example, provides the perfect environment for the growth of a new wealth management industry. A combination of strong and newly created middle and upper-middle class, well educated professional class, free-market economy, and expansion of disposal wealth will drive demand for wealth management products, both in the institutional and retail space, providing an enormous opportunity for disruption for existing players that want to grow or newcomers prepared to tackle these markets.
3. The 2020 COVID-19 recession had a short-term negative impact for many investors, but long-term the effect for many was surprisingly modest. The initial impact was largely cushioned by very aggressive government intervention with unemployment subsidies, small business association and disaster recovery loans, eviction protections, and massive buying of many market assets. However, the underlying problem is not necessarily demand-driven, as in previous economic recessions, but a massive life-style change due to a health crisis, which will lead to the permanent disruption of many traditional businesses and the creation of new business models. Most market observers expect increased debt levels and an expanding gap between the rich and the poor both within the developed economies and among developed economies and emerging markets. The trade-off we are likely to see is either far greater accountability for the wealthy (including investment managers), or much greater social unrest.
4. Investors are much more aware of new categories of risk. Most recently, COVID-19 taught the world to take the pandemic risk seriously. Eric Kohlmann, Venture Partner, Arc Ventures, is concerned about increased systemic concentration risk. “Many quant funds for instance rely on very similar factor models, often with the exact same factors. We have already experienced ‘quant quakes’ where factors suddenly move by 6-7 standard deviations. With investing moving substantially into passive strategies, ETF flows and quantitative trading models could well trigger a huge selloff with certain triggers. Such a ‘resonance disaster’ where overly similar models interact to trigger substantial selloffs is increasingly likely to happen.”
The overcrowding in the same investment models creates a major gap between volatility and uncertainty. Historically, when market forces drive market prices, volatility and uncertainty have moved in unison. However, market prices have been departing from fundamental drivers for a number of years now, because of the excessive stimulus by central banks. As a result, market uncertainty and volatility diverged, creating a structural risk in market prices. The problem is that most hedge fund investors, both quantitative and discretionary, use volatility to estimate how much leverage they should include in their portfolio. This has occurred more in recent years and especially today as markets have soared in the midst of a massive GDP contraction. When volatility and uncertainty diverge, it creates an environment for sudden and massive price corrections.
Source: CFR
Rob Li, Partner and Managing Director of Stone Forest Capital, a global fundamental equity investment manager, observes that during the first two weeks of the COVID-19 market meltdown, many high-quality supermarkets, such as Costco, plunged hard given massive sell pressure from quant trading. In retrospect, we know supermarkets actually benefited from COVID-19; Costco’s sales in fact tripled thanks to a COVID-driven nationwide lockdown. Yet machines chose to sell those supermarket “winners” because even the best algorithm has a fundamental Achilles’ Heel: algorithms need large amounts of historical hard data to make a decision to buy or sell. Since COVID-19 was an unprecedented global pandemic event, machines had no historical reference points to evaluate the situation and had to resort to crude, “dumb” strategy – follow the market (a.k.a., sell whatever is going down). This irrational algo-driven selloff hence, observed Rob Li, created a golden opportunity for long-term, fundamental investors: capitalize on the weakness of machines, and to generate significant returns amidst extreme market volatility.
It is a safe bet that we will see other tail risk events over the next decade: extreme climate events; large scale takedowns of critical internet infrastructure; electromagnetic pulse attacks, and who knows what else.
Source: Marto Research
5. Rapid technology innovation is generally positive for most money holders and will provide an opportunity to differentiate for intermediaries and money managers. We will see the greatest rate of change in the private markets. Historically, investing was a manual, artisan process. An investor had few hard metrics other than the actual financials, and little technology to make the process scalable. Over the past few decades, better metrics became available, and investors could take a more analytical, data-driven approach. An extreme example of this is algorithmic investors in the public markets, who design algorithms that trade on the designer’s behalf, as opposed to making trading decisions directly. High-frequency trading, algorithmic by its nature, is estimated to account for at least 50% of the US equity market’s trading volume.
Investing in public markets has already been massively impacted by technology and analytics. The next wave is going to hit the tech stack of the private markets. Quantitative, technology-enabled investing in private companies makes sense, but is structurally very difficult, and will become a more common strategy at a much slower rate. In venture capital, in particular, early-stage companies are often operating in frontier industries, where the rules are unpredictable and conventional analytic frameworks may be misleading. Even for later-stage companies with somewhat predictable financials, Trilliam Jeong, CEO, Wealthblock.ai, observes, “Data availability, data standardization and distribution are all major hurdles.” However, there is a lot of room to use technology to make the actual investing process more efficient.
Private equity and venture capital investors are now copying our sisters in the hedge fund world: we’re trying to automate more of our job. VCs tout our industry as frontier technology investors, but many of us are using the same infrastructure tools we have used for the past 20+ years: Excel and recent college grads searching Google. We’ve seen some modest progress in people upgrading from Excel to Google Sheets; use of CRM; and cloud-based storage services. Sebastian Soler, Founder, Techfor.VC, observes, “Structured, accurate, and accessible data never really existed before for the private markets, at scale. Advances in machine learning, specifically natural language processing, have made generating these baselines, aggregate datasets possible, at scale, with high accuracy. Sources like Crunchbase, AngelList, and SeedInvest even give this data away for free or very low cost. The problem that faces startup investors now is how to mine this new data layer efficiently to increase returns.” (If you’d like to learn more about how private equity & VCs specifically are using technology to enhance returns, we suggest join PEVCTech, an online community focused on helping investors in private markets achieve greater success through use of technology and analytics.)
Continue reading…
This is part of a series on disruption of investment management that I co-wrote with Katina Stefanova, CIO and CEO of Marto Capital, a multi-strategy asset manager, which creates customizable investment solutions for institutional clients. We based this on interviews with over 50 family offices, sovereign wealth funds, endowments, pensions, and other institutional investors.
- The Peculiar Investment Management Industry
- The Macro Trends Forcing Change on the Investment Management Industry
- What are the “Jobs To Be Done” of an Investment Manager?
- The Investment Manager of the Future
We wrote the first version of this research with Brent Beardsley, formerly a Partner with Boston Consulting Group.
Contributors
This study would not have been possible without the collaboration and support of Brent Beardsley and 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, plus more recently Ariel Cohen, Caleb Nuttle, Spencer Haik, and Cormac Ryan of Bullet Point Network, where David Teten is an Advisor.
Previously posted in Techcrunch
