The value proposition of the asset management industry is increasingly questioned, not only due to additional regulatory requirements and technology advancements, but also to new customer trends. Asset manager’s success with depend on understanding the customers decision journey and addressing his/her jobs to be done, considering technological advancements and regulatory constraints. Delivering superior risk-adjusted investment performance will be an important value proposition, but not the only one. Those asset managers that understand how customers define their goals, both rational and emotional, and align their offered value proposition with the goals will survive and thrive in an ever-changing world.
On November 28th, 2017, I attended a panel discussion organized by the ALFI (Association of the Luxembourg Fund Industry) on the future value proposition of the asset management industry in Zurich, Switzerland. Based on the panelists viewpoints, there exist five key questions that need answering when designing asset management’s future value proposition, especially from a fund provider perspective.
- What will “know your customer” mean to the asset management industry going forward?
- What role will investment performance pay as a differentiator, if any?
- How will regulations impact future asset management business models?
- What value can be expected from FinTech firms in the future?
- Which disruptive buzzwords will turn into trends that the asset management industry must not miss?
Let’s have a look at what the panelists believe could be possible answers.
1 Knowing your customer
Talking about knowing your customer in the context of asset management business models does not mean KYC in an anti-money laundry contest, but understanding the customer’s decision journey as well as his/her jobs to be done or needs.
In the traditional asset management world, there exists a three-party relationship.
- The asset manager produces performance/alpha and makes it available to one or more distributors for sale to end customers, usually through funds or fund like legal structures.
- The distributor picks up the asset manager’s products, ensures due diligence, and sells them to appropriate end customers by incorporating them into solutions, hopefully satisfying end customer needs.
- The end customer trusts the distributor and buys the solutions, including the underlying asset management products.
A key challenge with this model for the asset manager is, to understand who his actual customer is and what his/her needs are. Plainly speaking, is the distributor or the end customer the customer to focus on? Or both? How to cope with conflicting needs between distributor and end customer, for example, about suitability or remuneration? And who is going to pay what to whom?
To make it even more complicated, digitization, as thought-after by the end customer, transforms the relationship between the asset manager, the distributor, and the end customer, as shown in Figure 1. The traditional role of the distributor is replaced by technology platforms. The distributor’s role becomes one of executor of investment decisions and after-sales support, rather than sales.
According to the panel, this means that, going forward, asset managers need to focus much more on understanding the end customer’s jobs to be done and crafting products that address them, that is solutions, and that can be made available through platforms without requiring a one-to-one interaction between customer and asset manager or distributor. To achieve this goal, asset managers first need to focus on delivering performance to stay in the game. Second, they need to offer customized mass-produced solutions that stand up against competing offerings on a purely technology driven distribution platform. Key challenges will be to provide trust in solutions through a hopefully neutral technology platform without a direct one-on-one customer interaction. The good news is, that there exist lots of opportunities to innovate and differentiate that are not purely price driven.
- The battle for customer ownership has just begun and asset managers are not well positioned to win it. Understanding the customer decision journey will be key to be successful.
- Millennials have a different approach to investing than have earlier generations. They are looking for freedom of choice and ease of access, rather than standard or mass-produced solutions and human advice.
2 Investment performance
The panel is convinced that investment performance, whether relative or absolute, will provide a sustainable competitive advantage to an asset manager. This means that investment talent, identifying, hiring, and retaining the best and brightest people will become even more a key activity of any asset management’s business model.
In addition to investment performance, innovation capabilities on the road to finding that investment performance will be critical. Although not explicitly mentioned by the panelists, Porter’s competitive advantage framework seems to apply:
- Either asset management firms compete on price by delivering passive core building blocks providing performance as close as possible to that of an index.
- Or asset management firms differentiate through active management capabilities that result in sustained positive risk adjusted return after costs, packaged as active building blocks.
- Or asset management firms implement niche strategies, by focusing on combining building blocks and offering solutions addressing customer jobs to be done.
Especially with respect to the third type of business model, the niche solutions, and the drop out of retrocessions, the asset management industry may move from an open architecture to a closed one, or, at least a guided one, avoiding leaving revenues on the table. This again plays into addressing the question who is paying whom for what added value?
In addition to raw performance, the questions of how to cope with taxes, for example, capital gain and/or income taxes, if and where applicable, need to be addressed.
- Competing on investment performance will remain a fairy tale for all but a few asset managers.
- Providing passive solutions is a crowded business model with a big is beautiful mentality.
- I believe promising asset management business models can be built around the idea of niche solution strategies, focusing on offerings quality rather than asset quantity.
- Asset managers should define their distribution channels as target customers, whether human or technology driven, and develop offerings that satisfy their needs, rather than betting on getting a closer relationship with the end customer.
No panel discussion on asset management goes without mentioning regulations. When challenging the asset management industry’s value proposition, this is no different. Three topics were highlighted.
First, a significant trend towards transparency can be observed with the advent of the MiFID II and PRIIPs regulations. This is not necessarily bad, unless it is overdone.
Second, there is a tendency, especially by the EU authorities, to move towards a banking-like prudential regime for the asset management industry. This may challenge many asset managers with respect to capital adequacy questions in a delegation environment as well as the recurring question about liquidity of investments and associated risk management practices.
Third, the challenges posed by regulations, whether it be no more retrocessions, customer risk profiling, or suitability questions, to name just a few, with respect to the distribution model of the future is seen as the most prominent regulatory burden to be addressed. As inducements are no longer allowed, asset managers need to rethink how they want to distribute their capabilities and how revenues are generated. Then panelists identify three possible approaches:
- Asset managers may focus on becoming managers of discretionary mandates at the end customer level, rather than focus on pooled investment vehicles. This may be an option with respect to institutional customers, but poses a high burden when targeting private customers.
- Asset managers may focus on advising end customers rather than selling investment products. Again, a promising idea, with the challenge of how to handle a large number of customers. The buzzword here is one-to-many relationship.
- Asset managers may develop and sell holistic multi-asset class investment solutions (rather than building block products) wrapped in traditional fund constructions, including value-added services like tax reporting, that can be easily scaled and are perceived of value by the end customer.
The key question, to which the panelists did not have an answer, is how will the ideal distribution channel of the future look like in the light of consumer protection and how will the individual participants be compensated for their contributions?
- Embrace a customer-first mentality, and many regulations will look reasonable.
- Try to go the extra mile and transform a regulatory cost into a value for which customers are willing to pay a premium. Yes, that is easier said than done. But it provides a platform for innovation and differentiation.
- Understand that regulations exist for a reason, and that this reason may be your (or your competitors) past behavior!
The role of FinTech in the context of distributing investment products and solutions is seen in providing an innovative user experience that allows transforming costs for the asset manager via managing trust into value for customer. One panelist described the goal of FinTech to provide a Spotify® solution for investing. FinTech offerings may be better at providing customized solutions at a reasonable cost, especially as most of their business models are inherently based on a zero marginal cost.
The panelists see a key value-added of FinTech firms in handling big data and transforming big data into valuable information. Data frameworks will be able to extract knowledge and actionable insights from big data through structuring capabilities.
Interestingly, robo-advisors were not seen as a threat to the industry, predominantly based on their poor penetration as of today. To be successfully on a business model level, robo-advisors need to be able to provide value to customers in excess to cost savings. And this is not (yet) the case.
- It is key do differentiate between technology provided by FinTech firms and business models they try to implement.
- Asset managers should thoroughly screen for innovative technologies and look for potential problems that can be addressed.
- Technology should be seen as a business enabler rather than a disrupting factor.
- Do not believe everything you hear about FinTech. The FinTech industry still has a tough time aligning customer and business model understanding with technological expertise.
The panelists distinguished between FinTech and asset management industry disrupting trends. They identified as a key disruptive trend the asset management industry moving from an internal, product focused, mindset, to an externally focused, customer driven mindset. A second expected disruptor identified where novel user experiences offering a unique way of interacting with customers. Third, FundTech and RegTech technological trends are key for an industry that is built to a large part on economies of scale, to survive and grow successfully in the future.
To avoid being overrun by disruptive trends, that is living a Kodak moment, asset managers need to be open for change. That change may come from two areas:
- Customer needs will change over time, especially with respect to new customer segments, like millennials.
- Technology solutions allow delivering the value proposition more efficiently and more effectively, focusing on quality, cost, and risk management.
Make sure that your senior management activities include resources (time and money) for scouting, prototyping, and validating promising trends and ideas.
The panel participants agreed on two key success factors:
- Success depends on working together rather than separately, especially with respect to regulations and innovative technologies!
- Winners will be those asset managers that will succeed in (re-)gaining trust with their customers!
Although I can fully subscribe to the latter success factor, I have a challenging time embracing the former one, as I believe that differentiation is key to success and collaboration, open innovation, does not foster that differentiation.
If you are interested in discussing answers to these five questions with respect to your unique situation, do not hesitate to contact me for a first non-committal meeting. Alternatively, you may be interested in my “Think Tank your Business Model SM” solution relating possible answers to your business model.
 The customer decision journey refers to the path followed by a customer via so-called touchpoints before making a purchase decision.