The Investment Manager of the Future

Redefining Investment Management Through First Principles

What would an investment management firm look like if it were rebuilt from the ground up, guided by fundamental principles and a clear understanding of the core needs – the “jobs to be done” – of an investment manager?

Suzanne Ley, previously heading financial institutions at Westpac, notes that even platforms marketed towards younger investors, such as Betterment, RobinHood, and Wealthfront, are approaching their business models with limited scope.

The Influence of China's Approach

A crucial perspective lies in observing how China is pioneering a complete reimagining of our relationship with money and the investment process.

Consider Alibaba’s Yu’e Bao fund, which achieved the status of the world’s largest fund in a mere four years. The traditional boundaries separating shopping, banking, investing, and social interaction are rapidly dissolving.

Within the U.S. market, SoFi represents a comparable model – a comprehensive platform offering lending, financial management, and social networking capabilities. This integrated approach points towards the future direction of the industry.

Five Characteristics of Future-Ready Investment Firms

Below, we detail the five key characteristics that will define the successful investment management firms of tomorrow.

Technology

• Investment firms today: Rely on correlation models and predictive analytics based on historical data.
• Investment firms of the future: Will leverage data and data management as a core competitive advantage.

Big data, artificial intelligence, and social media will be instrumental in driving investment decisions.

Transparency

• Investment firms today: Operate within a regulatory landscape shaped by past crises, with communication primarily from the CIO to clients and regulators.
• Investment firms of the future: Will embrace regulatory oversight supported by independent boards.

Due diligence will be established as a continuous, systematic process for oversight and governance.

Risk Management

• Investment firms today: Employ siloed risk systems focused on asset classes, alongside static firm-wide risk assessments (like counterparty risk). Operational risk is also managed in silos.
• Investment firms of the future: Will prioritize risk management based on predictive indicators, rather than lagging data.

An integrated, dynamic risk management system will encompass both public and private/illiquid asset classes.

Alpha Creation

• Investment firms today: Focus on individual security selection, active fund selection, and asset allocation, often incorporating passive funds.
• Investment firms of the future: Will articulate investment strategies that span across all asset classes, including public and private/illiquid markets.

Actively influencing outcomes through investor engagement will become increasingly important.

Culture and Talent

• Investment firms today: Often prioritize a cohesive culture but lack robust talent management practices.
• Investment firms of the future: Will professionalize human capital management, including workforce planning and leadership development.

Firm leadership will be entrusted to a dedicated professional CEO, rather than a part-time CIO or sales executive.

Leveraging Technology to Redistribute Value to Investors

Investment firms are increasingly allocating resources to artificial intelligence and big data technologies. This internal investment is coupled with efforts to streamline operations by better integrating front and back-office systems.

Simultaneously, externally facing strategies involve the development of mobile and tablet applications, alongside an expanded presence on social media platforms.

The Future of Investment Models

Looking ahead, emerging investment models, particularly within the retail sector, are expected to merge investing with features drawn from social media, interactive gaming, and educational resources.

For institutional investors, technology promises more dynamic and highly tailored risk management and governance solutions.

Validation in Public and Private Markets

The effectiveness of quantitative models has been demonstrated by firms such as D.E. Shaw, Two Sigma, and Renaissance Technologies in public markets.

Currently, a similar trend is observed in the private markets, with companies like Versatile VC, Signalfire, and GV utilizing technology to enhance investment returns.

Building Confidence Through Openness

A shift towards greater clarity is anticipated, allowing investors to identify those managers genuinely prioritizing their interests. This trend suggests a potential decline in the appeal of hedge funds operating with limited transparency.

Amanda Tepper, the CEO of Chestnut Advisory Group, notes a growing expectation among investors for asset managers to provide communication that is clear, succinct, and consistent. A recent survey conducted by Chestnut revealed that 92% of investors consider communication to be a fundamental aspect of an asset manager’s role.

Furthermore, asset managers are facing increasing pressure to adhere to a growing number of regulatory stipulations.

However, regulatory bodies historically focus on addressing past issues rather than anticipating future risks. Consequently, we anticipate a rise in self-regulatory practices as a proactive measure.

For instance, certain private investment firms may form engaged executive boards. These boards will reassure investors and intermediaries that decisions are carefully considered and will establish a system of checks and balances concerning the Chief Investment Officer (CIO).

We also foresee a transformation of the current due diligence process. It will evolve from a largely manual and infrequent undertaking to a more structured, continuous system of oversight and governance.

Integrated Risk Management: A Holistic Approach

Historically, risk assessment has been compartmentalized, categorized into distinct areas like market, credit, and operations. A typical organizational structure often assigns market risk oversight to investment officers, while counterparty risk falls to treasury or the CFO, and operational risk to the COO.

This segmented approach is flawed, as risk isn't simply cumulative. Problems originating in one domain can trigger unforeseen complications elsewhere. Effective risk management necessitates a comprehensive perspective.

The Shift Towards Holistic Risk Assessment

Future-focused financial professionals will prioritize a holistic understanding of risk. This involves moving beyond reactive analysis of past losses – lagging indicators – and concentrating on predictive measures.

Proactive monitoring of leading indicators is crucial. These include factors such as employee retention rates, ongoing investments in essential infrastructure, and robust succession planning processes.

Why Siloed Risk Management Fails

• It overlooks the interconnectedness of different risk types.
• It can lead to undetected vulnerabilities.
• It hinders proactive risk mitigation strategies.

By embracing an integrated approach, organizations can better anticipate and manage potential threats, fostering greater resilience and stability. A unified view of risk is essential for long-term success.

Evolving Strategies for Alpha Generation

Historically, the pursuit of alpha – excess returns – centered on security selection, commonly known as “stock picking.” However, a shift has occurred, with increasing emphasis placed on identifying skilled fund managers to generate alpha.

Currently, the focus is evolving further towards asset allocation, encompassing both long-term strategic approaches and shorter-term tactical adjustments. Opportunities to generate alpha through individual security selection or fund manager expertise are becoming increasingly limited.

The Rise of Agile Asset Allocation

Future success in alpha generation will likely depend on the capacity to dynamically allocate capital across a diverse range of asset classes. This agility will be crucial not only in public markets but also within less liquid asset classes like private equity and real estate.

Effective allocation strategies will differentiate investors and unlock potential returns. The ability to swiftly respond to market changes and capitalize on emerging opportunities will be paramount.

Activist Investing and Portfolio Acceleration

We anticipate a greater utilization of activist investing strategies. This involves taking an active role in influencing the direction of companies to unlock value.

Within the realm of private equity and venture capital, a similar approach is embodied by investors who employ a “portfolio acceleration toolkit.” This toolkit typically includes seasoned operating executives and a network of specialized operational service providers.

Key Takeaways

• The focus of alpha generation is shifting from security selection to fund manager selection, and now to asset allocation.
• Agile asset allocation across both liquid and illiquid assets will be a key differentiator.
• Activist investing strategies, and their private equity equivalents, are expected to become more prevalent.

Enhancing Human Capital in the Investment Sector

Currently, the investment industry demonstrates a lack of sophistication in its approach to human capital management. This deficiency results in elevated employee turnover rates, insufficient succession planning, and a workforce lacking in diversity.

As firm founders reach retirement age and the composition of investors evolves, established investment companies will encounter significant talent shortages. A fundamental reassessment of strategies for attracting, nurturing, and retaining skilled personnel will become essential.

The Importance of Purpose and Dedicated Leadership

According to Jeff Hunter, CEO of Talentism, organizations guided by a strong sense of purpose are more likely to foster employee cohesion and dedication to both the company’s and investors’ interests. A clear focus on purpose cultivates a more engaged and productive workforce.

We anticipate the development of a dedicated Chief Executive Officer role within asset management. This leader will concentrate solely on overall leadership, differentiating from the conventional roles of Chief Investment Officer (CIO) and Vice President of Sales.

Leading Firms Demonstrate Proactive Strategies

It is important to recognize that certain asset management firms, such as D.E. Shaw and Blue Mountain, are already taking initiative. They are proactively prioritizing the management of their organizational culture and core principles.

These firms serve as examples of how a forward-thinking approach to human capital can mitigate future talent-related challenges. Their efforts highlight the growing importance of investing in employees and fostering a positive work environment.

Areas Ripe for Innovation

The Current Asset Management Landscape Disadvantages Individual Investors

Currently, limited high-quality investment avenues are available to individuals with a net worth below $1 million, despite this demographic representing a substantial $147 trillion global market. Several innovative business models are targeting this segment, notably AI-driven advisory services and social trading platforms like Ayondo, Collective2, EToro, Sprinklebit, Zingals, and Zulutrade.

Furthermore, companies such as Republic are emerging, providing retail investors with direct access to alternative investment funds previously unavailable to them. The user experience associated with investing often lacks the engagement and enjoyment found in interactive experiences like video games. The financial services sector could benefit from adopting engagement strategies prevalent in the consumer internet realm.

Improved Incentive Structures are Crucial

Investors consistently express a willingness to compensate for genuine investment outperformance. However, they are increasingly concerned about paying excessive management fees and undisclosed expenses, irrespective of investment results.

Novel intermediary services and collaborative industry initiatives can empower institutional investors, family offices, and individual investors to gain clarity regarding the true cost structures within their investment funds. This increased transparency will ultimately facilitate more informed investment decisions and longer-term allocations. Establishing and enforcing standardized industry benchmarks is essential.

A particularly innovative approach involves designing business models that more closely align the interests of fund managers with those of their investors. Adage Capital, a $23 billion hedge fund, exemplifies this by charging fees solely on alpha generation – receiving performance-based compensation only when exceeding benchmark returns and refunding fees during periods of underperformance. Aperture Investors, founded in 2018 by former Alliance Bernstein CEO Peter Kraus, directly links fund management fees and portfolio manager compensation to the alpha produced by its funds.

Addressing Pension Fund Challenges May Require Policy Changes

Ensuring alignment with liabilities is a key priority for both the $12 trillion defined benefit (DB) pension system and the U.S. government. Conversely, the rise of defined contribution (DC) plans has transferred investment risk from employers to individuals. A growing concern is achieving equity between employees participating in DB plans versus those in DC plans, ensuring fairness for all.

A significant opportunity exists to assist pension funds in managing both defined benefit and defined contribution plans concurrently for a company’s workforce, maintaining consistent transparency and governance as the industry transitions from DB to DC models. Several leading administrators are actively developing integrated platforms to facilitate this evolution.

A Shift in Leadership is Necessary

The ownership structure of many money management firms is dominated by individuals approaching retirement age. Data from Imprint Group indicates that “one-third of currently managed assets are overseen by men over the age of 60.” This situation presents challenges related to talent retention, succession planning, and long-term business stability.

The departure of Chris Shumway from his hedge fund, for instance, triggered substantial redemptions, forced asset sales, and ultimately led to the closure of a previously successful $8 billion fund. Technologies and firms specializing in audit and risk oversight can provide limited partners with insights into founder/partner departure risks. However, these often monitor existing conditions without fully grasping the internal leadership dynamics that determine the success of these critical transitions.

Looking Ahead: The Future of Asset Management

Money management firms poised for growth will be those capable of both scaling their operations and fostering innovation. They must effectively address the complete range of investor needs – encompassing technical expertise, functional requirements, and emotional considerations.

Such firms will not merely adopt more professional management structures internally. They will also see economic advantages as capital shifts away from competitors struggling with leadership, especially in areas like succession planning.

A Declining Standard and Emerging Opportunities

Ashby Monk, in his work “The New Dawn of Financial Capitalism,” suggests that current industry benchmarks are so diminished that simply avoiding negative outcomes for investors is considered success. The present challenges within the asset management sector are creating openings for new entrants to disrupt the status quo.

Those established firms that navigate these shifts most effectively will be those that recognize their core competencies and proactively adapt to emerging trends. They will transform potential disruptions into advantageous opportunities.

Transparency and Acknowledgements

Disclosures:

Katina Stefanova holds investments in AcordIQ and Long Game, and previously served as a Senior Executive at Bridgewater.

David Teten has invested in a variety of investment technology companies, including Addepar, Asaak, Clarity (acquired by Goldman Sachs), Drop Technologies (Cardify), Earnest Research, Indiegogo, Republic, Stratifi, Wonder, and Xperiti. He also provides advisory services to Bullet Point Network.

Contributions and Support

Contributors:

The initial draft of this analysis was developed in collaboration with Brent Beardsley, a former Partner at Boston Consulting Group. This research was significantly aided by Brent’s contributions and the support provided by Boston Consulting Group.

We extend our gratitude to the research, technology, and editorial teams who assisted throughout this study: Greg Durst, Jen McPhillips, Jenny Wong, Charles McLaughlin, Michael Rose, and James Ebert. Further support came from Ariel Cohen, Caleb Nuttle, Spencer Haik, and Cormac Ryan of Bullet Point Network.