Future Asset Management Thesis

Future Asset Management By Hendrik Schwarz, CMT, CAIA Financial industry trends are transparency, diversity of funding, deposit taking, greater supervision and regulation leading to higher barriers to entry and probably fewer larger institutions. As baby boomers age, balance between accumulation and preservation shifts. The current market environment extends the length of the selling cycle (the cycle through which a potential investor moves from prospect to investor). The willingness to rationalize product will allow Economies of Scale in marketing and operations. For asset mangers, the only hope and the only sustainable advantage is an enhanced value proposition by aligning clients and firms’ interest. The asset management industry faces an era where massive debt is being extinguished. This is not a great time in history to be a saver. How does the asset management industry address that?

How do consumer and car companies handle marketing, distribution, product and operational set-up? VW’s platform strategy must be a role model on many levels: A) Business

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Move away from the old integrated business model of doing every thing inhouse, to the new business model of focusing on the most value-adding processes. Outsource a variety of services that go well beyond custody and settlement and make effective use of prime brokers, administrators, auditors and other service providers.

B) Product - Similar products have to be approved centrally. - Beneath different products should be identical back office and computer systems. The mutual fund industry is a marketing industry. Procter&Gamble as the biggest global advertising spender is well known for its contrarian ad spending habit allowing P&G to maintain its market leader position in addition to win market share from competitors. This is the time for taking this as a unique opportunity to be in front of clients as others retreat behind near-term cost controls. Brand image is (almost) everything… Our financial system is based on trust. Trust, however, is an emotional issue and the marketing strategy must take this basic fact into consideration. Is the DWS brand strong enough compared to the longevity and familiarity of the DB brand? Offer products clients actually need (not what we have) and focus on product’s quality. When you would offer those, how would you differentiate yourself from your competitors? …with a clear emphasis on empathy than strategy Funds that are activist and are working to improve the value for all shareholders through their work and investment in companies represent a big opportunity for longterm value creation for the firm and its marketing. Focus on governance of companies will become better understood as a way of adding significant value to client portfolios in addition to leading public opinion in the companies’ strategy, which would reflect the firm’s relationship to the world and how it is viewed by others. Investors would feel empowered and feel like it's their right to participate in and effect change. This could potentially address the challenge that younger investors accumulate much differently than Baby Boomers. Incentives need a clear alignment between managers and clients Rather then start the race to the bottom by reducing fees, lead the industry remodelling its fees, e.g. performance fees should be paid on a three-year view of overall performance of underlying fund, or follow the Private Equity fee model by only generating performance fees in the de-investment phase, and certain funds may choose to trade for a lower management fee for more secure capital (“sticky assets” in return for an increased lock up period of invested clients’ funds). Finally all investors are happiest investing when they know the manager has a sizable stake in the fund alongside their own. Through the implementation of all of the above the firm would

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become a leading example for the industry. Furthermore it would convince the regulator rather than react out of the defensive. Act ahead of the regulator Regulators are struggling with identifying better solutions in order to address financial markets issues. The opportunity for the investment business is to do more to help government and regulators better understand the important role that they perform in allocating capital within the economy and help shaping laws and regulations. Asset management should introduce their own “special independent audit”, communicating proactively a new best practice approach to the market and their clients. The new audit format would be imaginable, say every three years, in addition to the annual audits. This special audit would focus on risk, illiquid position valuation, tier ratios, etc.. Seeking Alpha = Sound operations Operational issues have had lower priorities in the recent past. What is being done to improve operational excellence in the back office to mitigate various risks that worry clients? What is done to fully realize UCITS III full potential of sophisticated risk controls? Add fresh blood Bringing in some people who are experienced in, and confident about, using options and futures, managing unconstrained mandates and looking across the capital structure could energise investment teams who have found it hard to navigate the last year without access and knowledge to hedging tools. There is also potential for mainstream managers setting up some kind of white labelling agreements with existing hedge fund mangers. Note only mainstream asset managers who can offer relatively modern infrastructures and a progressive approach to business are well placed to “in source” significant talent from the hedge fund industry. Distribution is the new Asset Management Complex advisory solutions are increasingly left in the hands of distributors. Retain more of the economics of the relationship by cutting out the middle man and move closer to the centre of individuals' long-term financial planning needs. There are five major needs of consumers: -

savings, mortgages, brokerage, consumer credit and current accounts.

10-20 products across the five major consumers needs are sufficient to satisfy clients and for a sustainable business. What are these products? Treat your clients as you would treat yourself

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There is demand for absolute return strategies, combined with an element of principal protection. For example, a focus on stable income generation in a tax-effective manner that meets the individual investor's varied needs or an improved (vs. regular insurance company product) annuity program. There is, however, a contradiction between the demands for simplicity while simultaneously asking for downside risk management. Balanced funds with a holistic approach are one answer to client needs Balanced funds are an easy to understand ‘All-in-one’ product which clients have demanding for some time (see charts). Balanced funds are simple and therefore easy to market. They offer many advantages such as they steer against the human procyclical behaviour of retail clients decreasing their equity allocation when equity volatility increases. They can help to shift assets out of fixed income and money market funds where the revenues are less. And finally balanced fund’s performance is less volatile compared to equity funds.

Source: Merril Lynch

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Source: BVI The ultimate mandate Emphasise on tailor-made products offers two routes: -

Create building blocks for an individual asset allocation construction kit. Utilise the Riester-engine for made-to-measure balanced funds.

Who will be left to distribute? The internet has been affecting consumer behaviour in material ways. Many industries such as entertainment or consumer electronic goods struggle with distribution. Will increased regulation and public criticism lead to a paradigm shift of the financial distribution model? Is this the end of open architecture? Direct retail access facilitated by Non Bank Institutions selling financial products to retail customers is a big opportunity. Question Investment Banks Investors learned that the short-term-transaction-orientated investment banking culture sits ill with their long-term goals. There could well be a realisation that, investment banking products and services needs to be filtered through long-termorientated asset managers with sophisticated risk-management and analytical skills. Hunt on tax heavens could change European private banking market … A special off-shore product focus along special marketing efforts may not warranted going forward. At the same time “soft tax optimised” products (using long lock-ups to acquire favourable tax treatment and simultaneously “sticky” assets) could lead to repatriation of funds back to onshore markets. Beta is the next bubble to pop

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Increasing regulation of investment managers and their processes is driving everyone towards a consensus and benchmark-driven portfolio which can lead to poor outcomes which would penalise the ultimate savers. Beta won’t outperform equity indices going forward when active management would become a minority. There is always a bull market… The financial bear market is giving way to a powerful new bull market in politics and for the first time in many years, US domestic politics will become a central concern for investors around the world. The background assumptions of the past three decades - that there will be no major changes in trade, immigration, and tax policy - have become unreliable. Where does global trade/finance go, in a post-US-consumer world? The capitalist model is fundamentally questioned, e.g. including whether capitalism’s emphasis on economic growth ultimately threatened the planet. Is this sort of viewpoint becoming the mainstream? What will be the way to measure investment success when people are against economic growth?

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