Thoughts on the Future of the Asset Management Industry

This is my final column as Chairman and CEO of OppenheimerFunds. On May 24, the sale of OppenheimerFunds to Invesco is expected to close. I am confident the new, consolidated firm will serve our clients well. Both firms share the same investment philosophy: investment teams are given the independence to exercise their expertise in various asset classes, while still adhering to shared governance and risk management principles.

The transition has me thinking about the future of the asset management business. The disruptions the industry has faced in the last few years will only intensify. At a minimum, there will be enormous consolidation of companies. What will the hallmarks of successful firms look like?

To understand this, we first have to understand the customer. This means understanding what the customer needs, not what the customer wants. Successful firms, whether advisory or asset management, will forge lifelong relationships with customers by creating practical and realistic savings plans, for any purpose. There are three pieces to any savings plan, in order of importance:

1. Save. I use the term savings plan rather than investment plan because the surest way to create wealth is to defer some consumption. Putting money aside is a “sure thing.” You can’t invest what you don’t have. Just saving the $3 a day you spend on coffee (drink the java in the break room) will add up to tens of thousands of dollars over decades, and even more once it’s invested. Even sticking your money in the mattress will become substantial if you are disciplined.
2. Make a plan and stick with it through market ups and downs. There has been much hoopla in recent years about active managers underperforming the market. The biggest drag on returns is bad timing. Selling low and buying high is human nature. I see it in every downturn. People sell at the low and then “wait for things to settle down” before getting back in, by which time, of course, the market is back up. That means the temporary downturn in the market has been converted to a permanent loss. Don’t do that. Instead, decide on your goals. Understand your tolerance for risk. Invest accordingly. Then don’t touch it! Let it run. Yes, the market will go down sometimes. So what? The game is rigged - in your favor! Most years are good ones for stock markets, as they should be. If you believe in human progress, you should expect to win over the long term. A good financial advisor can be helpful here. All advisors probably do a decent job of coming up with appropriate asset allocations. The bad ones retreat into a hole when the market is doing poorly. The best ones actively reach out to remind you about your plan and give you the confidence to stay the course.
3. Choose the right asset manager. It pains me to admit it, but this is the least important step. All that stuff about active vs. passive, high fee vs. low fee and a manager’s “secret sauce” pales in importance compared to saving and sticking to your plan. Once you get to this step, the most important attribute of a good active manager is a process that you understand. Don't be seduced by the recent track record. Don't buy something you don't understand just because the fees are low. Be sure you understand what the value proposition is. Know the conditions under which the strategy will do well and do poorly. Ideally, when the strategy underperforms, and it will, you will already know why. Good managers are good communicators. 

Successful managers of the future will understand these customer needs and will become trusted partners in the savings journey.  At the same time, they will need to navigate key factors.

Pressure on fees increasing the need for cost efficiency.

Investors – both individuals and institutions – want to pay lower fees on their investments. For decades after mutual funds were introduced in the 1920s, the upfront sales charge on stock funds was more than 5%. Throughout the history of the industry, there has been a continuing demand from customers to lower sales charges and management fees. That has impacted not only the traditional asset managers, but even newer entries like hedge funds. The hedge fund managers that used to be able to charge “2 and 20” – which translated into an annual fee of 2% on assets managed, plus 20% of any gains realized – are now charging 1% and 10%.

As fees are lowered, asset managers will have to continue to find ways to operate more cost efficiently. Managing investments is not a capital-intensive business, but it is people intensive. One change companies are already implementing – on an increasing basis – is to use more quantitative approaches to evaluate securities and risk. Active management will always have a human component, but the decisions talented investment professionals can make will be made more efficient by the insights quantitative analysis can provide. I view it as a force multiplier for outstanding human talent.

Active management continuing to thrive where it can make a big difference.

In recent years, passive products have made significant inroads. It has some, often members of the financial press, asking if active management has a prolonged future. But the answer to that question is much more nuanced than a simple “Yes” or “No.” It is true that in certain, highly efficient markets (like large-capitalization U.S. stocks) a low-cost, market-cap-weighted, exchange-traded fund (ETF) can be a cost-effective solution for investors.

Once you get beyond the U.S. large-cap stock market, though, fully passive, index-based products can be less appealing. In some markets, like emerging markets (EM), the index represents a very undiversified portfolio, both in geographic and industry dimensions. Many of the companies in the EM index are state-owned enterprises that do not have “creating value for shareholders” as the primary goal influencing their decisions. I am not saying active managers will always beat the EM index. I am saying they will likely construct a portfolio with better risk-reward characteristics. In other markets, like floating-rate bank loans, the index is difficult to replicate. Passive vehicles will paradoxically build in a performance drag to replicate the holdings of the index. In these and numerous other markets, there is a tremendous value to having active managers select what they believe are the best investment opportunities.

Offering more customized solutions for investors who need them.

It has been said that the investment business is becoming increasingly commoditized. That is true for certain products – like U.S. stock index funds – where there can be little differentiation between asset managers’ products. For mass-market retail investors, passive vehicles can serve their needs well.

For many investors, the best strategy for long-term goals is to leave your money alone and let the compounding of annual returns do its work.  High-net-worth investors often have more complex needs. For example, they may want to integrate their tax-planning objectives into the investment strategies, or they may have specific goals concerning sustainable investments they would like to implement.

Already, firms like OppenheimerFunds and Invesco have been bringing to market products that can be tailored to the specific needs of investors. The active managers who can continue to do that best will thrive even amid the increased competition in the industry.

Expanding the product set by moving away from daily liquidity.

Daily liquidity is the feature that initially distinguished mutual funds. We talk all the time now about the importance of industry disruptors, and that attribute was truly disruptive when it was introduced nearly a century ago. Convenience is often considered the hallmark of mutual funds – and daily liquidity is really what makes mutual funds so easy to use. The ability for investors to get their money back on the day they request it is a tremendous benefit and a true differentiator. Liquidity may seem to be the core of our industry. Still, as we evolve and address new challenges, the asset management industry will have to become more comfortable with, and innovative about, offering products without daily liquidity. 

Originally mutual funds offered access to the broad market as another innovative feature for which they could charge. Those days are over, but access to newer markets is something the industry can provide now. The private equity and private credit markets offer significant investment opportunities for those with the net worth and risk tolerance to be able to consider less liquid products. We have already taken steps to make these products available, and I am sure there is much more innovation to come.

There is a cautionary tale here, however. One of the dangerous games asset managers play is offering customers more liquidity than the underlying investments warrant. We hope that when financial meltdown happens, the doors are wide enough for everyone who wants out to get out. During the financial crisis, most mutual funds did an admirable job providing liquidity. The customers may not have liked the exit prices, but they got out. Recently ETFs in less liquid markets have exploded in popularity. In the next crisis, I predict many ETF owners will get a rude awakening when they find the market price for the ETF they try to sell is way, way below the theoretical asset value. Caveat emptor.

Making the customer experience more digital.

While everyone values in-person customer service, there is no question that it is more expensive for businesses to deliver. Today, though, people don’t always need or even want the personal touch, as long as the alternative isn’t a constantly branching automated phone line. A great digital experience not only improves customer satisfaction but will also help lower costs and help the industry offer more attractively priced products to customers.

I am not talking about the current crop of "robo-advisors" – we are only at version 1.0 of digital advice, with easy access to products and crude pie-chart allocations. Everybody thinks the way forward is merely evermore transaction convenience. China is already there. I saw an amusing promo for a Chinese mutual fund showing a young woman on WeChat booking a dog grooming appointment, a dinner date with friends and, oh, I almost forgot, buying shares in a mutual fund. And it was all so easy! I am talking about using digital to provide routine nudging to help investors with all the steps in the plan. There are a few apps that encourage savings, and we need to see much more of that.  We are used to pop-up alerts on our phones for every blip in the daily news cycle. I envision pop-ups that don't scare, but rather reassure investors that their investment programs are on track even when CNBC is shrieking about how much the market is down today. 

 A Focus on Clients

As I look back on my career, it gives me tremendous pride to have helped people pursue their personal goals, like enjoying a comfortable retirement or providing a good education to their children. I have had the benefit of working with hundreds of very talented and dedicated colleagues who have served OppenheimerFunds’ clients for more than 60 years, and I was lucky to be there alongside them for more than half of that rich history. I am confident of the legacy the firm leaves behind, and the ability of the newly combined firm to navigate the key factors driving change in the industry. They will do this, no doubt, while continuing their commitment to serving clients.