By Jay A. Burstell, Managing Director, Asset and Wealth Management Advisory
For players in the asset management sector in 2014, the phrase “this is not your father’s mutual fund” most certainly comes to mind. In fact, one could argue that AM hasn’t seen such a torrid pace of product development since the derivatives boom of the ‘90s. And, as with derivatives in the ‘90s, this pace of AM product development has the potential to disrupt and dislocate existing investor-manager relationships as well as create significant market opportunities for more nimble firms.
Riding this wave of new product development – as opposed to being eclipsed by it – may require new capabilities and firm behaviors and may necessitate a break from historical product management practices. AM product manufacturers that can act nimbly to align emerging product structures with investor demand may have a distinct advantage. In some cases, product manufacturers may even choose to get significantly “out in front” of new product opportunities, by shaping emerging market demand through marketing, investor education and targeted client efforts.
Let’s take a quick look at just a few of the key trends that have contributed to the aggressive pace of AM product development.
1. The re-thinking of some pre-Global Financial Crisis (GFC) assumptions
- Stable correlations exist that allow investors to diversify their holdings and manage risk across different market scenarios: What was witnessed in the GFC was a market environment where many correlations rapidly “went to one”…that is, all assets traded down together.
- The proprietary nature of managers’ investment processes implies that investors will have less individual security and/or credit concentration risks, where multiple managers are utilized: Though marketed as “unique and proprietary”, the investment processes of many managers nonetheless exhibited enough commonality such that they wound up holding many of the same security names (and often for the same underlying investment reasons).
2. The search for performance
- Low yield environment with global challenges to growth: Political leaders are challenged as to how to accelerate the pace of growth globally, while some of the growth leaders of the past few years (e.g. China, emerging markets) show signs of slowdown and/or political instability. Government stimulus spending has not sufficiently stoked the growth engine and artificially low interest rates may be politically challenging to unwind.
- Alternative investments will make up the performance gap: We have seen a pronounced period of moderating performance across both more and less liquid strategies. As a result, picking the right investment thesis and manager (and exercising appropriately detailed diligence) has never been more important.
3. Continued fee pressure
- Alpha-beta separation: Much has been written in the scholarly literature about – simply put – whether it pays over the long-term to invest through active management. The passive investing boom (largely through index funds and ETFs) is a testament to the attractiveness of strategies that provide beta/market exposure at significantly reduced fee levels.
- Enhanced beta and cheaper alpha: A whole new class of products has emerged (enhanced/smart beta) that attempts to improve on basic market-cap weighted index tracking. Separately, active portfolio management styles can now be delivered to investors an ETF product structure (active ETF / AETF) with greater resulting fee, tax and trading efficiencies. AETFs are a nascent product category (currently comprised of mostly fixed-income AETFs) that may compete with active mutual funds for investor assets over the longer term.
- Alpha-only fees: Certain AI strategies have had their historical “2 and 20” fee structures come under pressure from both institutional and high net worth investors following the GFC. In the marketing process, these fee structures have been positioned as the cost of truly un-correlated performance and a unique and proprietary investment process. As mentioned earlier, the GFC has caused the value of these aspects of the investment process to be challenged.
4. Demographics and the need for retirement solutions
- Guaranteed income and dynamic allocation structures: With tens of thousands of baby boomers retiring each month, investment products are needed that provide guaranteed income and/or more dynamic adjust of asset allocations dynamically (based on holding year, or other similar factors); annuities and target date funds are such product examples.
- Retail retirement funding gap: The retail market is also experiencing a retirement funding gap. Investors are concerned about the slow pace of wealth creation and fee impacts as well as the need to enhance performance outright. This is driving retail interest in lower fee and enhanced alpha products (e.g. ETFs, retail alternative investments).
All of these key trends can be considered drivers for new product opportunities for managers, and – when taken collectively – posed a large change management challenge. This is because product development is by definition a series of disruptive events and as with any disruptive event, there can be clear winners and losers. In order to adapt and thrive, asset managers need to contemplate the many criteria that ultimately determine the effectiveness of their product management function and critically analyze each. Among the most important of key criteria are product strategy and product infrastructure:
A clear product management strategy: Understanding where the market is headed, over what time frame and how this compares with current products, client segments served and firm capabilities and differentiators is key. For example, even if a new product is expected to be a financial success, there is a need to consider whether being an “early-mover” creates an advantage. Where cannibalization may occur, this should be dutifully modeled as part of the complete business case supporting launch; Managers may be incented to move more quickly to cannibalize their existing products rather than allowing competitors to do so.
A flexible product management infrastructure: There are many aspects of the product development infrastructure that organizations can focus on to become more nimble and effective – three key areas are:
- A robust new-product-approval (NPA) process: This is one component that – when functioning as desired – anticipates the people, process and technology requirements for the product, assess gaps versus current capabilities and guides remediation of these gaps, all in a timeframe that does not negatively impact the planned timing of the product launch. For example, specialized roles and skill sets may also be required to launch and support new products and there may be no guarantee these can be easily sourced either inside (or outside of) the manager’s organization. In the case of AETFs, there is often a need for a role of interaction with market makers in order to drive product trading volume and liquidity. This role is not present in traditional mutual fund environment and has been cited in industry as being critical to the successful launch and sustainability of this product.
- A persistent governance and feedback process: This typically includes external (investor) and internal assessments of success areas and areas for improvement. It also stresses transparency of and reporting on true product costs and profitability; this helps to continuously course-correct and accurately measure results. Key questions typically addressed by the governance process may include distribution effectiveness, investor education requirements and internal product controls effectiveness.
- A flexible systems infrastructure: Infrastructure may need to be built or modified to handle new aspects of the investment process and/or middle and back-office processing and accounting. Applications and operational processes that allow for new product adoption while limiting extensive and/or proprietary development as well as non-institutionalized “work-arounds” should be sought. For example, In the case of liquid alternatives some structures may employ leverage and/or derivatives which do not fit neatly into traditional 1940 Act mutual fund systems and processes and may thus require specific or customized solutions that will have to be balanced with the existing product infrastructure.
In sum, there are numerous market forces driving rapid product innovation in the AM sector. This can spell opportunity for managers who look critically at their product management functions, assess their strengths and weaknesses and move rapidly toward the alignment of product capabilities and offerings with current and anticipated demand. And if the manager needs to behave differently to do so, then the choice becomes clear: adopt the practices and infrastructure to be nimble and ride this wave, or be forced to play catch-up.