Edition: September / November 2017
Adaptation is the name of the game.
Active investment is far from dying, Natalie Phillips* insists.
The retirement fund industry, and the role of active managers in it, are at a critical juncture. Not only is the growth in passives continuing unabated, but we also ask ourselves whether big data and artificial intelligence should be viewed as opportunities or threats.
Will we be able to navigate these waves of change, or will we allow technology companies to disrupt our industry and become the dominant players in our space? Added to this, these major shifts are taking place in an environment where people are living longer and the savings rate remains abysmal.
In attempting to set out how we as asset managers should approach these challenges, the Quartz watch “crisis” of the 1970s and 1980s provides a compelling analogy. The entire Swiss mechanical watch industry was near collapse after failing to anticipate and adapt to Japanese competition from battery-powered quartz technology.
The situation was dire. Within a decade the Swiss dropped from holding 55% of the world’s export market to 30%, and their export volumes decreased from 45% to 10% of watches distributed globally.
Swatch, under the leadership of Nicolaas Hayek, together with the legendary vision of Jean Claude Biver, managed to embrace and adapt to the challenges. Ultimately, they recognised that ‘Quartz had no soul’ and that clients would still have an aspirational motive.
In the same way, we recognise that as an active manager we remain in the service of clients. They are brand aware, have aspirations and want a personalised level of service. After all, clients are people who want to work primarily with other human beings and not just machines.
In addition, despite the rise of machines, no matter how good a model is, there is still an element of randomness that machines will take longer to detect. The element of human behaviour that machines will find hard to replicate is the ability to pick up long-term structural patterns in society when tracking data, trends and signals.
We also do not accept the argument that active management is dead. Without active, who determines prices? In a June 2017 paper published by Investment & Pensions Europe, titled ‘Top 400 – active and passive, an ongoing debate’, the authors provided evidence to suggest that an economy without active investing would be inefficient from the viewpoint of capital allocation and in the discovery of efficient prices. The end game is not zero.
Furthermore, according to a paper by Credit Suisse in March 2017 titled ‘The Incredible Shrinking Universe of Stocks’, the number of listings in the US fell by 50% between 1996 and 2016. There are now more indices than stocks in the US. As a consequence, a large part of the market resides in the unlisted space for active managers to exploit.
|Phillips . . . brand strength
To future-proof our business as a successful investment manager, I believe there are steps we can take as the industry evolves.
We need to embrace change and adapt to demand. Our clients will become increasingly discerning about quality and integrity of product. As an active investment manager our investment offering should be niche, best of breed and supported by a cohesive brand. We cannot compromise on these.
We also need to respond appropriately to demand for product so that we can offer clients more choice in-house rather than potentially lose them to a competitor. Once a client is lost, it can take at least a decade to win back their trust.
Given the increased commoditisation of the industry as platforms, passives and artificial intelligence will grow. We shall have to become even more active in this space by offering outcomes-based solutions to clients.
Then, as a consequence of consolidation, there is also likely to be a more intensified war for talent. We shall have to position ourselves as the kind of employer who can attract the best people.
To win in the active space, a business will need small teams with specialist active niche skills that have limited capacity.
Overlaying all this, we must ensure that we always put clients first and respond appropriately to their needs.
Returning to the Swatch analogy, we could effectively follow the example it set in showing (to borrow from Mark Twain) how reports of its imminent death were greatly exaggerated. Swatch took a near-bankrupt firm to a business now worth almost $2,5bn. Its forward-looking leadership chose three clear routes in brand development and product differentiation.
At the highest end of the market, it turned around a failing Blancpain watch. In the middle to high end, it grew Omega from 350m to 900m units. For the mass market it introduced the cheaper, quartz Swatch brand to compete directly with the Japanese brands Casio and Seiko.
The strategy bears similarity because we too can leverage cost, resource and product efficiency along distinct lines to cater for the needs of our varying client base. We have the benefit of longstanding client relationships that have built trust.
Ultimately, our clients are people who want to develop meaningful business interactions. It is for active managers to ensure that we adequately respond to their needs and aspirations.
* Natalie Phillips is head of SA institutional at Investec Asset Management. This is the first in a series of articles where a range of asset managers will offer views on how to face an era of unprecedented industry change.