This article appears courtesy of Global Investor.
GLOBAL INVESTOR: What do asset managers need to do to stay profitable in the next decade?
Paul Bateman, CEO, JP Morgan Asset Management: Performance is the only reason that investors come to us – they want their money returned to them, plus some extra. If we don't do that consistently they won't leave their money with us, or they won't give us any more. So for any asset management business you need to focus on establishing investment performance. Everything else follows from that. Of all the disciplines that you need to run a business - people retention, continuity, expense control - you can't lose focus on generating investment performance, in a risk defined way. It's always been that way and it always will be, it's just the techniques that have continued to evolve.
Chip Mason, CEO, Legg Mason: Performance is always the number one issue, but beyond this, there are a lot of other issues floating around - for example, the stability of the world economy and terrorism. These could affect investment cycles and how close investors want to stay with cash.
In many ways, US money managers have to try to stay tuned and follow trends outside of the US. Australia is a good example of what changes are going on - there is a need to be in the multi-asset management business. You cannot just concentrate on one thing, because as trends emerge, it will make it difficult to shift from your current focus to doing something else. So you can't just be in equities, you also have to be in fixed income; you can't just be a value manager, you have to be in value and growth.
Hendrik du Toit, CEO, Investec Asset Management: This is such an immensely profitable industry I have no fears about that - winners will always make a great deal of money. But to stay relevant, asset managers need to run their clients' money properly and that means taking adequate risk, and building real long-term views into the portfolio. Asset managers have become used to hiding behind their mandates when they do badly for their clients. I keep asking myself whether the time for total portfolio management has not returned.
In the specialist world we are all used to getting just a slice of the client's overall portfolio, and whether that makes money or not is down to the client's restrictions or portfolio design. It seems that the attitude of some in this industry is, 'If the client's not asking questions, we keep the clients and collect the fees.' We should be taking ownership and telling the client and their consultant when we think that they should be doing something else. Don't hide behind the mandate. You should encourage decisions that are right for the client and not for short term profit. Real winners understand that this is the ultimate long-term business. It is all about trust and integrity. Ultimately this is not a transaction-oriented business, but a relationship business.
Todd Ruppert, CEO, T Rowe Price Global Investment Services: They need to strategically respond to changing needs and not make knee-jerk reactions to what may only be fleeting fluctuations in demand. Too much time and effort has been expended on chasing outlier demands.
Whilst brand and scale are important in many respects, there is a fallacy that they equal profitability. You don't need to have a massive geographical presence and a big product range to be profitable. There are many good examples of small companies that are very profitable because they are focused and disciplined in what they do. Sometimes scale can be a disadvantage. Growth for growth's sake can be very pernicious.
Blake Grossman, CEO, BGI: Asset managers need to be able to respond and adapt to the changing demands of DB plans, and the rise of DC plans, which will herald the need for more individual solutions. The next five years will be a period of dramatic change and conventional solutions won't be as interesting to individuals.
Ray Dalio, founder and CIO, Bridgewater Associates: As with the technological changes in the telecoms industry in recent years, investment management is going through a big sea-change. It centres on the separation of alpha from beta: we are entering a new era in which fund managers will create optimal beta and optimal alpha portfolios. Managers will become one or the other. Those who employ this approach have an enormous competitive advantage and it totally changes the game because an investment manager can now compete in any asset class - all alpha managers will be competing with each other regardless of asset class.
Ted Sotir, co-head, GSAM Europe: Each asset manager needs to think what its value statement will be for each client channel. Some clients will see it as alpha, while others will see it as less about alpha and more about client service. Something else that is important - particularly in the retail channel - is innovation. In the retail space asset managers will have to develop mass-market products. For institutions, because they are more likely to give managers a much larger chunk of money to invest, then asset managers may be able to do something that is more customised.
GI: Do you see the industry changing radically over the next 20 years? How?
Du Toit: We're at the start of convergence between the so-called alternative and traditional parts of this industry. That will be a very important change. It will lead to a very clear differentiation between the commoditised part of this industry and the value-added part. We'll see a split between the genuinely active (alpha-seeking) and the index or low risk managers. That means we ought to stop using the terms alternative and traditional, and those who classify themselves as one or the other won't survive. Today the world's biggest hedge fund is run by BGI, an index manager. One of the biggest fund of hedge funds businesses in the US is hidden inside the bowels of Blackstone, better known for its private equity prowess. This is only the beginning.
Philippe Collas, head, GIMS, Socgen: Yes, especially in the range of products that is being created. During the last five years there has been a shift towards active management. Now everyone is trying to get into alternative investments and high alpha products. Those that will be successful will have not only invested in people but in technique and products, as well. This may have a bearing on the small boutiques that are not able to invest in IT tools and risk management.
Sotir: It is less likely that a new manufacturing company will open a defined benefit pension plan. So the question is, how is DC going to grow? That means asset managers are going to have to think about what products they need and they will have to focus their sales forces more on the HR side because DC is aimed directly at the worker. Do employees know the various asset managers' brands? I'm on the GSAM pension plan so I see it from the other side too and that makes me think about the total value statement DC clients will expect.
You don't want to be a large brand that does not seem to care about people. GSAM had an active TV campaign in Tokyo about five years ago. We had a Saturday morning investment show. It was expensive but it had a halo effect for us and created a brand image for GSAM in the DC market. This strategy takes patience and many years of investing.
Jeremy Grantham, CEO, GMO: Yes. Pension funds as we know them are in a disillusionment phase ie, they are being deconstructed. There's been a lot of discussion on whether the lion's share of a pension portfolio will move over to fixed income. But hedge funds have impacted the industry enormously, as we all know. Having said that, they don't exist in isolation. Stocks, bonds, commodities are coming up with some interesting curves
as well.
Joachim Faber, CEO, Allianz Global Investors: If you look back 20 years, there was no internet and think about how this has changed our lives. I think the world will look completely different in another 20 years. In terms of our industry, there will be more globally connected platforms, trying to contribute to the retirement funding challenge.
Grossman: The market has become more sophisticated and investors are more demanding about separating alpha and beta. The ramifications of that for the industry will be quite profound. The current bifurcation between hedge fund investing and mainstream investing is quite artificial. I think beta managers will have to adopt more hedge fund style techniques if they want to stay vibrant.
The advantages of scale will also accelerate. Institutional investors are seeking a broader range of solutions so managers with scale will benefit. The opportunity to innovate and add value derives from the ability to operate across a number of different asset classes and regions.
Jack Brennan, CEO, Vanguard: The obvious change will be new markets opening up. The traditional hubs of asset management, such as the UK and US, won't grow at the rate of China or other emerging markets. There will also be a change in the percentage of assets managed in non-traditional strategies over time.
Indexing and ETFs will continue to pick up market share as the alpha/beta debate works itself out. Some people are overpaying for beta so you will see more assets shifting to the indexers. And being a closet indexer won't be acceptable.
Mason: I do not see the industry changing radically, but I do see a transformation in the US over the next 20 to 30 years to a focus on Europe and Asia. Growth rates in the US are much smaller than in other parts of the world. Ten years ago the US was much further ahead – but that is less true now. It's hard to do well if the assets around you are not growing.
Bateman: People will say it is changing because relative benchmarks are disappearing. When I came in to the industry in 1968 there was no such thing as a relative benchmark. People gave you their money to produce the best relative return available. I don't think the industry is approaching new ground now, it's approaching new ground in the way it can deliver.
What's survived is a focus on investment performance. I joined Save & Prosper, one of the biggest UK mutual fund providers in 1968, and in the early seventies The Economist ran a story with the headline: "The end of capitalism." It just shows the situations we have survived – a massive credit crunch, with markets going down, 1972 and 1974, the Asian crisis, the late 1980s – these cycles do come round. One of the things I've learned about investment management is that you have to be able to prove to your client that they can trust you. To do that you need continuity of people, with the decisions they have made.
GI: What will be the biggest challenge for asset managers in the next 20 years?
Du Toit: In this fast-changing world, to remain true to the core of this industry, which is managing money on the behalf of clients, taking sensible long-term decisions, and not succumbing to fads that are produced by changing buyer behaviour. I think the industry may be losing some of its monastic qualities subsequent to the loss of its initial mystique. Today this is an extremely transparent industry with horizons that are increasingly short-term. The industry needs to reconcile its duty as a long-term fiduciary with the short-term governance requirements of its clients. We resist the temptation to stuff clients with inappropriate products at the wrong time and encourage our people to think long-term, and try to convince our clients that this is the right way.
The other area to think about is how do you navigate the move from DB to DC? That area is going to change substantially in the next 20 years. When the history books are written, I would not be surprised to read about 2005 as the year when the UK DB business died.
Bateman: Whatever size you are, going forwards there is going to be a structural challenge. Long-only managers are looking at hedge fund capabilities and vice versa. I had to look at this pretty seriously after we did the deal between JPM and Chase, because once you become a certain size you can't rely on any single area of strength or single style of investing. Therefore, you face the question of: 'How do I get a multiple of styles on to this platform, working together with some form of homogeneity that will be beneficial for the clients?' What we tried to do is structure the investment teams so that they feel as if they own their own business and get paid accordingly.
Grossman: The challenge will be to respond to the major structural changes taking place. On the DB side that means having the ability to separate alpha and beta, and looking at how efficient that beta is, and how consistent the alpha will be. Historically the industry had relied on offering beta solutions and charging an alpha fee, but a number of business models will be challenged by the move towards alpha/beta separation.
Ruppert: Hiring, training and retaining high quality talent to consistently create superior value for clients. You have to be able to evolve and expand your value creation capabilities whilst making sure that you don't undertake any activities that will impair that. For example, are you prepared to close funds to new business if it is detrimental to performance to keep gathering assets?
Sotir: Focus, because a manager might not be able to pick every customer channel. Also, everyone will have to think about capacity. This is something that hedge funds think about all the time. You ask a hedge fund what its capacity is, and they might say, for example, US$2 billion. You don't tend to get that response as quickly in the long-only world. I do not think capacity philosophy is ingrained as much in long-only, but now that everything is excess-return focused, asset managers may have to start thinking about capacity.
Collas: To be within the top 20 in the world. There won't be any room for those who are not in that league. In a matter of years, a handful of firms will be running US$2-3 trillion. The challenge will be to stay competitive. That will require a lot of innovation, strong alternative investment products and the best talent in the marketplace.