The Next Frontier: a #NewFundOrder

by: RMI Investment Managers

Date: Aug 22, 2018

RMI Investment Managers recently hosted Jon Beckett, author of the book #NewFundOrder and director at the Association of Professional Fund Investors at their Leading Insights Seminar.  He shared his views on how the world of asset management and fund selection is entering the next frontier.  Having experienced three market crashes throughout his 20-year career, he is well qualified to address how and why technology is changing the face of asset management.


The Old Fund Order


“Technology is a 200-foot Godzilla; it advances, unrelenting,” according to JB. Its target: the Old Fund Order, characterised by asset concentration and supertanker funds.


He likened the effect of Donald Trump’s protectionist moves to what has happened in the UK asset management industry post-RDR as financial advisers have become disenfranchised from asset managers. In the same way that Trump’s economic and political walls give him greater power over what’s inside those walls, big asset managers have increased their control of the market following RDR (retail distribution review, the UK’s regulatory reform aimed at improving transparency in financial services).


“Assets have concentrated and grown faster in the UK since RDR than ever before; importantly, faster than fee margins have fallen. This has created supernormal profits and free cashflow to squeeze the competition and buy rivals and technology disrupters,” JB said.


He quoted that approximately 70% of global assets under management are concentrated in just 10 fund groups.


“The Old Fund Order has progressively pooled investors into a handful of common strategies and often failed to deliver”, he said.


The efficiency advantage of boutiques


However, with size comes certain disadvantages. Of particular relevance to the asset management industry is what’s called “Parkinson’s Law”, the observation that organisational efficiency decreases as the number of employees rises. JB himself has undertaken extensive research in this field, finding that many large asset managers face significant inefficiencies across their front- and mid-offices.


“Big creates friction, drag and a lack of agility as assets rise into the multi-billions”, he said.


The bigger the fund, the harder it is to scale ideas into trades and create alpha because liquidity issues may force a significant overlap with indices. This is why, in an age dominated by supertanker funds, smaller boutiques offer more nimble market access but the battle is ongoing. It is a question of the tug-of-war between the economies of scale that can be achieved by big funds and the focused-outcomes that smaller boutiques can attain.


Smaller boutiques are less human-intensive


With less human capital, boutiques are not as vulnerable to technology cannibalising jobs and can therefore wholeheartedly embrace the technological change that is apace in the industry, to their advantage.


“With their smaller teams and resources, boutiques are optimally placed to use technology to drive home their agility in terms of human intensity”, JB said.


He cited Martin Ford’s book “Rise of the Robots” in which the author hypothesises that over the next 20 years, robots will take over many white collar jobs.


We are already seeing the loss of countless jobs that characterise the Old Fund Order. JB also quoted Martina King, CEO of Featurespace as saying that “In the insurance sector, reducing the number of highly skilled, highly paid actuaries by replacing them with technology is attractive to companies… In other sectors too, organisations are slotting into job ads the request for experience in machine learning.”


Godzilla advances


So just how is machine learning affecting the industry?


On the advisory side, JB pointed out that Morningstar has launched its own robotic fund ratings system, with obvious consequences for its 180 global fund analysts. Elsewhere, SharingAlpha (the world’s largest fund rating platform today) is disrupting the fund rating field using crowd research to rate funds in the most efficient and accurate way.


The due diligence and RFP processes are becoming digitised too. Fintech firm Door has established the first truly global digital due diligence platform with the aim of creating greater efficiencies in the due diligence process while InvestRFP has done a similar thing on the RFP side.


“Together, e-due diligence and e-RFP platforms will revolutionise the way fund selectors engage with asset managers”, according to JB.


He also pointed out the potential for fintech to transform ethical and sustainable investing. He referred to companies such as SustainAnalytics, MSCI, FTSE, South Pole and ISS-Ethix and praised their pioneering efforts in helping investors better understand and incorporate sustainability factors into the investment process.


Robots and regulations


Much has also been made of the advent of robots in the advisory field, with CitiGroup forecasting that robo-advisors will manage $5 trillion worth of assets in just the next decade[1]. There has been some interesting work done that shows just how powerful these robo-advisors can be, particularly as regards fund selection. JB cited a study by Robert Ludwig and Michael Piovoso done in 2005, the results of which showed that machine learners used in manager selection outperformed humans.


Robo-advisors are already shaking up the industry in unprecedented ways, but they do present a number of challenges, particularly as in terms of regulation. According to JB, there needs to be a hardwiring of protections, the monitoring of outcomes and of course, programmers will have to be closely regulated.


This is already happening in the UK, with the FCA’s proposal of a new certified regime for algorithm programmers, given their potential to cause significant harm to a firm or its customers.


Importantly robo-advisors need to be able to act in a fiduciary manner for clients. JB believes this is not implausible.


“Tomorrow’s coders will need to have technical knowledge of both finance and programming in order to satisfy a fiduciary test. This is an area that small fintech start-ups and boutique asset managers can exploit”, he said.


Greater transparency on the horizon


Turning to the regulatory backdrop, JB pointed out how the growth in artificial intelligence in advisory has been amplified in the UK by RDR. “The effect of banning product commission and raising qualification thresholds has been to reduce the independent adviser population. Banks and robo-advisors have filled this advisory void”, he said.


Indeed the Financial Conduct Authority (FCA) has been highly sceptical of the ability of human consultants to choose outperforming managers and actually deliver for their clients. He also drew attention to the findings of the investigation by the Competition Markets Authority (CMA) into the fund selection practices of the “big four” consultancy firms. The enquiry showed little evidence of value having been added to the end client.


“Have big consultants become more skilled at convincing clients into mediocre choices with strategic asset managers?” JB asked. “More often than not, big firms select big firms and they become locked into strategic fee deals”, he said.


He believes advisers should be regulated more heavily, and this is something he has been campaigning for, so he has welcomed the FCA and CMA’s attempts to introduce more competition to the asset management and investment consultant markets.


“We now appear to be on a course to reduce the market share of big consultants through mandatory tendering”, he said.


Although RDR was the catalyst to the current digital revolution according to JB, the regulatory landscape post-RDR continues to evolve. Advisers are set to come under increasing scrutiny as the authorities focus on improving fee transparency and limiting commission and research costs, as evidenced by the introduction of MiFID2.


The next frontier


The asset management industry is undergoing a major transformation and the next frontier is upon us as players recognise the efficiency advantages of small boutiques, as artificial intelligence encroaches on human capital and as regulators demand greater transparency across the board.


To stay in the game, we must adapt and advance alongside these changes. Becket recommends that technologies such as artificial intelligence be integrated into current business models, striking a fine balance between technological scalability and human intensity.


According to JB, “In many ways, the Old Fund Order is already dead; it just takes a long, long time for the nerve endings to tell the central brain. The #NewFundOrder has just begun”.


[1] Beckett, J. “AI looms over the city: Godzilla approaches”, RMI website, March 2018