An Industry Musing: Spring 2019
The Game Changers: Streaming Music and Passive Management
As a lifelong audiophile and lover of music, I have seen and heard the impact of the mass movement to convenient and cheap. The music recording industry, once defined by the pressing of vinyl records, is now dominated by streaming music and MP3 file downloads with half (or less) of the audio resolution of their CD predecessors, which themselves have far less resolution than records. And while music consumers have access to more music content than at any other time in history, arguably their experience has never been worse; clinical, cold, and computer generated.
Conversely, while the occasional crackle and pop of vinyl records ostensibly interrupts an otherwise wonderful presentation, the listener experience always remains aurally tethered to the soul of the performer and their performance. It is for this reason that turntable and record sales have resurged while CDs have become all but extinct. Finally, humans are again connecting with humans.
As with music, today’s investors have more investment options than ever before. This is largely due to the ascension and dominance of passive investments. The almost rabid mass market moves to cheaper beta tracking funds have all but upended the active alpha market as assets are draining out and forcing significant fee compression. Consequently, active managers are spinning in place trying to regain their footing and doing so through such measures as smart beta strategies, fulcrum fee-based products, etc. And let’s not ignore the frantic acquisition and consolidation spree meant to reduce competition, expand asset class diversity, and stabilize revenue. Yet, none of this addresses the root reasons for the migration to passives. Active strategies continue to bleed out to the seemingly lower fee and “less risky” index funds and ETFs. Institutional, corporate, and retail investors have practically abandoned the alpha experience to live a content life of beta-based returns. It is not a coincidence that the human connection between investor and alpha manager has been broken. As with music, this disconnect is a reflection of the times; transactionally “cheap and easy.” And so, today’s unrelenting challenge for active managers is to resurrect the alpha value proposition and reconnect with their investors. In the end, performance is simply not enough. The alpha differentiation needs to exceed the perceived value of “cheap and easy.” This will be the only way for the active manager to remain relevant and retain and acquire client assets.
Today’s unrelenting challenge for active managers is to resurrect the alpha value proposition and reconnect with their investors.
Differentiation in the New Paradigm: The Human Experience
Let’s face it, convenient and cheap are not the only reasons for the rise of the passive space. Investors lost a significant amount of market confidence during the 2008 financial crisis. Besides the financial impact of losing 10 years of returns, the psychological scars remain across multiple generations of investors. Therefore, the promise of returns and strong performance is not enough. Trust and confidence need to be restored and the successful alpha manager will be the one that reconnects to the human side of the investor.
In fact, true differentiation will be realized with the optimization of the “human experience.” Do not confuse it with the client experience or client journey — two of the most overused terms since “big data.” I believe that the human experience, within the context of active alpha management, is the persistent and proactive connection that advisors and client managers maintain between themselves, the alpha managers, and the clients; like the vinyl album that keeps the listener tethered to the soul of the performer and their performance. Please note that the connection needs to be genuine and authentic and requires a persistent commitment and dedication to nurturing the client relationship. Response times need to be instantaneous and, in many cases, predictive of client needs. Achieve this and client assets will become sticky as they remain with or return to alpha based strategies.
True differentiation will be realized with the optimization of the 'human experience.'
How to Make it Happen: Aggregate, Reconcile, and Report
Reconnecting with clients on an emotional and human level seems so obvious and yet it is not easy to achieve. Why? I mentioned earlier the massive move to industry consolidation. Middle and back office systems have proliferated causing innumerable custodians and multiple accounting, performance, and reporting applications with client data strewn across all of it. As a result, highly skilled and well-paid client managers and advisors are spending an inordinate amount of time collecting investment data from disparate systems into desktop tools all in an effort to provide their clients with consolidated holdings and performance reports and statements. The client suffers significantly because they cannot get the timely attention of their client manager or readily access daily consolidated holdings and performance data and are left feeling uneasy as market volatility reinforces their anxiety. Consequently, relationships are weakened and related assets become a flight risk.
Returning to the music metaphor: the ultimate goal is to enable the client manager to tether their clients to the soul of the performer and their performance. This can only happen if the client manager is unburdened of tasks associated with manually aggregating data, calculating performance, and creating reports.
The holy grail is the adoption and employment of a data aggregation tool that is agnostic to source and capable of normalizing whatever it ingests; multiple asset classes across countless custodians, accounting systems, spreadsheets, etc. Now envision that this single repository of clean investment data is reconciled daily against order management, custodial and accounting sources. Lastly, performance is calculated daily and made available to client managers and their end clients via a web interface and configurable statements. Imagine a data and reporting solution so empowering that active management can once again differentiate itself — but this time via the intimate engagement with its clients. Do not confuse any of this with enterprise data management (EDM) tools or fancy bolt on reporting solutions. The real solution is an integrated data and reporting system that is holistic and all encompassing; multi-asset, data source agnostic, with daily reconciliation and reporting available to everyone within the alpha management value chain. Do this and you will marginalize the perceived value of the passive funds and once again be the preferred choice of investors as advisors and client managers reconnect their clients to the alpha experience. Finally, humans will again be connecting with humans.
The real solution is an integrated data and reporting system that is holistic and all encompassing; multi-asset, data source agnostic, with daily reconciliation and reporting available to everyone within the alpha management value chain.