I have been invited to contribute thoughts on the future of asset management to CFA UK’s Professional Investor magazine. I thought I would use this forum as a dry run. I propose to use the ‘rule of three’, three times: three lenses, three issues, and three choices.
Three lenses
I believe the Thinking Ahead Institute is trying to promote improvements in (a) investment strategies, (b) organisational effectiveness and (c) societal legitimacy. The first is a logical starting point, and where most debate occurs – the growth of index-tracking, smart beta, factors, active ownership etc. Organisational effectiveness is about converting inputs into outputs. A quick scan of the horizon shows the approach of digitisation / roboadvice, the retailisation of pensions, the insourcing / professionalisation of asset owners, and regulatory change. Throw in softer considerations such as culture, and we believe organisational change will be inevitable. And then there is societal legitimacy, or the licence to operate. We suggest that any industry that loses its licence to operate eventually suffers.
Three issues
Issue 1 – adoption of complexity frameworks, models and coping strategies
TAI papers such as State of the industry and Stronger investment theory and practice have made the case that the world is a complex, fast-changing, inter-connected place. However, grappling with complexity is hard work, and somewhat humbling and depressing; first, there are no easy answers; and second, we must give up the pretence that we get to control the outcomes. Nevertheless, the prize – improved outcomes – is worth shooting for.
Issue 2 – sustainability of…
This flows directly from issue 1, and you can pick your topic: DB delivering on its liabilities, DC in its current form providing meaningful retirement income, capitalism in its current form, climate etc. Many of the necessary changes are beyond the investment industry’s direct control, but there are things we can do, such as better governance, longer horizons and choices which shore up trust.
Issue 3 – the next financial crisis
While certain measures have been taken to reduce the likelihood and severity of any future system-wide crisis, it remains arguable what level of risk the system continues to run. So what should the investment industry be doing in terms of investment strategies, organisational effectiveness and societal legitimacy? This leads us to the three choices.
Three choices
Choice 1 – how will we define success?
We would contend that the current investment industry defines success as producing single-period, short-horizon, cross-sectionally-diversified, time-weighted relative returns. There are two problems with this. First, in aggregate, the industry cannot produce a positive relative return – so we are setting ourselves up to fail. Second, and more importantly, our clients need multiple-period, long-horizon, time-diversified, money-weighted returns. We believe that if the industry chooses to re-align with the needs of the end saver we will see significantly different investment strategies, differently organised firms, and vastly improved societal legitimacy.
Choice 2 – do we want to be a business or a profession?
CFA UK recently published a paper entitled The value of the investment profession. The paper is an excellent review of the status quo, but it repeatedly refers to the ‘profession’ of investment and makes no reference to the ‘business’ of investment. The vast majority of individuals in the industry are employed by for-profit businesses, and we cannot afford to overlook that aspect in an assessment of our collective future. At the risk of being too contentious, we suggest that businesses are run for owners (shorter-term profits) and professions for clients (longer-term profits).
Choice 3 – how should we structure the value chain?
This was the subject of the recent TAI topical day. The biggest learning point for me was that we should lift of our focus from our own small sphere of operation (whether we add value), and engage more with the health of the entire investment value chain. After all, the whole chain must hold for value to flow through to the end savers. Less immediately practical, is to consider the changing environment (eg the rise of DC) and to recognise that we may need to re-work the value chain to meet changing client needs.